Digitized  by  tine  Internet  Arciiive 

in  2008  witii  funding  from 

IVIicrosoft  Corporation 


littp://www.arcliive.org/details/carefulinvestorOOmeadricli 


THE  CAREFUL  INVESTOR 


THE  CAREFUL 
INVESTOR 


BY 

EDWARD  SHERWOOD  MEAD,  Ph.D. 

PROFESSOR    OF    FINANCE    IN    THE    WHARTON    SCHOOL    OF    FINANCE 
AND   COMMERCE,    UNIVERSITY   OF   PENNSYLVANIA 


PHILADELPHIA  &  LONDON 

J.  B.  LIPPINCOTT  COMPANY 

1914 


^b  s^ 


< 


Copyright,  1911,  1912,  1913.  1914.  by  J.  B.  Lippincott  Company 


Published,  January,  1914 


PRINTED    BY  J.   B.   LIPPINCOTT   COMPANY 

AT  THE  WASHINGTON  SQUARE  PRESS 

PHILADELPHIA,   U.  S.   A. 


DEDICATED  TO 

CHARLES  CUSTIS  HARRISON,  LL.D. 


PREFACE 

American  investors,  under  our  crude  and  care- 
less methods  of  finance,  have  lost  incalculable 
amounts  of  money  by  purchasing  bad  securities. 
Not  alone  has  the  "get-rich-quick"  company 
preyed  upon  the  investor,  but  hundreds  of  millions 
have  been  lost  in  the  bonds  and  stocks  of  railroad, 
public-service,  and  industrial  corporations — secur- 
ities often  issued  under  the  auspices  of  responsible 
and  respected  banking  houses,  but  which,  either 
because  of  defects  in  the  securities  which  a  careful 
preliminary  examination  would  have  disclosed,  or 
because  of  bad  financial  management,  have  failed 
to  come  up  to  expectation. 

Made  wise  by  costly  experience,  the  American 
investor  has  grown  critical  in  recent  years.  He 
is  disinclined  to  speculate.  He  looks  for  security 
before  income.  He  asks  many  questions  concern- 
ing assets,  earnings,  the  quality  of  management, 
the  strength  of  franchises,  the  extent  of  monopoly 
control  possessed  by  the  companies  into  which  he 
puts  his  money.     It  is  no  longer  easy  to  victimize 


PREFACE 

him  with  junior  Hen  mortgage  bonds  or  with 
inflated  stocks. 

Investment  bankers  have  also  learned  that  a 
reputation  for  sound  judgment  as  to  the  value  of 
the  securities  which  they  offer  is  their  greatest 
asset.  Competition  for  the  investors'  money  is 
growing  constantly  more  strenuous.  Salesmen 
are  quick  to  seize  upon  the  weak  points  in  the 
securities  offered  by  other  houses.  The  banker 
cannot  afford  to  take  chances  by  selling  bonds  of 
whose  merits  he  has  not  thoroughly  satisfied 
himself. 

Out  of  the  growing  caution  of  the  investor  in 
buying  securities,  and  the  desire  of  the  investment 
banker  to  take  no  chances  as  to  the  quality  of 
what  he  offers,  has  been  developed  a  body  of 
sound  financial  knowledge  which  is  constantly 
being  utilized  to  increase  the  security  of  invest- 
ments. Improvement  has  proceeded  so  far  that 
it  is  now  possible  to  offer  the  investor  thoroughly 
safe  bonds  which  will  yield  a  much  higher  rate  of 
interest  than  was,  until  recent  years,  thought  con- 
sistent with  secimty. 

This  book,  the  outgrowth  of  a  series  of  magazine 
articles  which  has  followed  a  fairly  consistent 
plan  of  arrangement,  aims  to  present  some  of  the 


PREFACE 

accepted  opinions  as  to  what  constitutes  a  safe 
investment.  The  author  claims  no  special  ability 
in  indicating  sound  investments,  but  he  is  con- 
fident that  close  adherence  to  the  cautions  laid 
down  in  the  following  pages  will  keep  the  investor 
from  buying  investments  which  are  unsound. 

Edward  Sherwood  Mead 

Philadelphia,  1914 


CONTENTS 


PAGE 


CHAPTER 

I.  The  Chances  of  a  Lamb  in  the  Stock  Market.  .     ii 

II.  Stocks  or  Bonds 36 

III.  The  Corporation  Mortgage  and  the  Deed  of 

Trust 50 

rV.  The  Banking  House  as  an  Aid  to  Investors.  ...     61 

V.  The  Business  of  the  Investment-Banker Ti. 

VI.  The  Reliable  Investment-Banker 83 

VII.  Public     Obligations— Municipal    Bonds    Pre- 
ferred       93 

VIII.  High-Yield  Municip.a.l  Bonds 108 

IX.  The  Americ.\n  R.ailway  Industry 115 

X.  Railway  Labor  and  Railway  Investment 123 

XI.  "A  Reasonable  Return  upon  the  Value  of  the 

Property  Devoted  to  the  Public  Service"  . .    134 
XII.  The  Securities  of  Public-Service  Corporations  142 

XIII.  The  Investment-Banker  and  the  Public-Util- 

ity Company ^54 

XIV.  The  Public-Service  Corporation  and  the  City  163 
XV.  The   Public-Service   Commission  and   the   In- 
vestor      ^77 

XVI.  Fari{  Mortgages 185 

XVII.  The  Mortgage  Bank i97 

XVIII.   Industri.al   Bonds  and  Railroad   Bonds  Com- 
pared    2°^ 

XIX.  Timber  Bonds 222 

XX.  Industrlal  Preferred  Stock 232 

XXI.  The  Dissolution  of  the  Trusts 244 

XXII.  The  Investor  and  Gold  Supply 261 

XXIII.  Price  Mox-ements  Since  1865 268 

XXIV.  Investor  and  the  Future  of  Prices 275 

9 


THE 
CAREFUL  INVESTOR 


THE  CHANCES  OF  A  LAMB  IN  THE  STOCK 
MARKET 

Complaints  of  the  extreme  dulness  in  business 
are  rife  in  all  stock  brokerage  houses.  The  "pub- 
lic" is  not  buying  stocks.  Brokers  are  reduced 
to  the  expedient  of  preying  upon  one  another. 
Meantime  expenses  continue,  and  there  is  no 
relief  in  sight.  "For  this  condition,"  said  a 
veteran  broker,  "the  muck-raking  magazines  are 
responsible.  They  have  denounced  Wall  Street 
and  Wall  Street  methods  so  persistently  and  with 
such  violence  that  the  people  have  come  to  look 
on  the  term  'Banker  and  Broker'  with  suspicion. 
They  do  not  want  to  trust  brokers  with  their 
money.  They  feel  that  they  will  not  be  treated 
fairly.  They  do  not  beheve  that  the  Wall  Street 
game  is  honest." 

11 


THE  CAREFUL  INVESTOR 

"Is  it  honest?"  he  was  asked.  "Are  the  people 
correct  in  their  opinions?  What  about  this  criti- 
cism of  the  financial  game?  Do  you  believe  there 
is  anything  in  it?" 

"Well,"  he  replied,  "I'll  tell  you  my  own 
opinion.  The  magazines  are  right.  There's 
nothing  in  the  game  for  the  people  except  excite- 
ment, worry,  and  loss.  If  a  man  sticks  to  the 
stock-market  game  long  enough,  he  will  lose. 
While  he  is  playing  it,  unless  he  is  careful,  he  will 
be  made  the  victim  of  some  trick  of  manipulation 
which  will  take  his  money  away  from  him,  with- 
out even  giving  him  a  run  for  it.  Of  course,  it's 
my  living.  I  like  the  business.  I  try  to  be  fair 
to  my  customers;  I  know  I  am  honest  with  them; 
but  sometimes,  when  I  stop  to  think,  I'm  sorry 
for  them.    They  haven't  a  chance." 

Such  candor  is  imusual  and  refreshing.     Read 

the  solemn  editorials  in  the  newspapers  when  it  is 

proposed  to  abolish  or  restrict  the  stock  exchange. 

Note  the  indignation  with  which  any  such  proposals 

are  received.     "Without  the  stock  exchanges  and 

the  brokers,"  we  are  assured,  "business  could  not 

be  carried  on."     It  is  admitted  that  there  are 

abuses.      Foolish    men    speculate    to    their   ruin. 

Occasionally  a  broker  turns  rogue,  makes  a  dis- 

12 


A  LAMB  IN  THE  STOCK  MARKET 

honest  failure  because  he  speculated  for  his  own 
account  with  the  money  of  his  customers.  But 
these  are  only  incidents.  They  furnish  no  reason, 
it  is  said,  to  overthrow  a  great  and  beneficent 
institution,  or  even  to  hamper  or  seriously  inter- 
fere with  its  operations.  Through  the  stock  ex- 
changes capital  is  mobilized,  brought  together  in 
great  masses  for  railroads  and  subways.  The 
buying  and  selling  of  the  brokers  for  their  cus- 
tomers and  for  themselves  establishes  the  values 
of  stock  and  bonds.  The  stock  exchange  discounts 
future  events.  If  the  com  crop  is  threatened  by 
drought,  down  go  the  prices  of  Western  railroad 
stocks.  Is  a  trust  threatened  with  attack?  The 
stock  exchange  knows  before  any  one  else,  and 
the  ticker  tells  the  story.  Without  the  stock 
exchange,  the  banks  could  not  make  loans  on 
collateral  with  any  safety,  since  they  would  have 
difficulty  in  finding  a  quick  market  in  case  it 
became  necessary  to  sell. 

These  are  strong  statements.  They  have  high 
authority  to  support  them.  They  are  not  to  be 
questioned  without  the  production  of  strong  evi- 
dence that  they  are  overdrawn.  Certainly,  they 
will  not  be  questioned  here. 

While,   however,   we  may  recognize  the  stock 
13 


THE  CAREFUL  INVESTOR 

exchange  and  the  members  thereof  as  public  bene- 
factors, indispensable  parts  of  the  intricate  plan 
of  things  as  they  are,  it  is  well  to  look  at  the  situa- 
tion of  the  man  or  the  woman  who  makes  the 
stock  exchange  and  the  brokers  possible — the 
margin  speculator.  It  is  the  speculator  who  pays 
the  commissions.  The  commissions  build  the  ex- 
changes, pay  the  rents  of  the  brokers'  offices, 
maintain  the  costly  private  wires,  and  support  the 
modest  establishments  of  the  thousands  of  men 
who  get  their  living  from  the  business.  The  bills 
for  these  are  heavy.  The  speculator  pays  these 
bills.    What  does  he  get  for  his  money? 

First,  let  us  clearly  understand  the  nature  of 
margin  speculation  as  carried  on  through  a  stock 
exchange  house.  You,  let  us  say,  are  a  merchant. 
You  have  a  good  bank  balance  or  some  sound 
investments.  You  believe  that  Atchison  com- 
mon at  par  is  too  low.  You  think  the  price  will 
advance.  You  resolve  to  take  advantage  of  the 
rise.  You  secure  an  introduction  to  a  broker. 
How  glad  he  is  to  see  you — especially  in  times 
like  these.  You  give  him  an  order  to  buy  500 
shares  of  Atchison,  costing  $50,000,  for  your 
account  and  risk. 

You  do  not  have  $50,000.    Your  available  re- 
14 


A  LAMB  IN  THE  STOCK  MARKET 

sources  are  only  $5,000.  But  this  is  no  barrier  to 
the  transaction.  Your  broker  is  also  a  banker. 
He  will  lend  you  the  difference  between  $5,000  and 
$50,000,  and  will  buy  the  500  shares  for  you,  pro- 
viding you  will  leave  the  stock  on  deposit  with 
him  to  secure  the  loan.  The  purchase  is  made. 
You  give  the  broker  $5,000  in  cash  or  securities. 
He  borrows  $45,000  from  a  bank  or  trust  company 
and  buys  500  shares  of  Atchison,  as  he  notifies 
you,  "for  your  account  and  risk." 

I  once  heard  a  broker  describe  the  resulting 
situation  and  its  developments  as  follows. 

Says  the  broker  to  his  customer,  or  "client": 

"You  own  500  shares  of  Atchison,  costing  $50,000, 

and    worth    $50,000    to-day.      Of    this    $50,000, 

$5,000  is  your  money  and  $45,000  is  my  money. 

Suppose,  now,  that  the  price  of  Atchison  goes  up 

10  points.     Your  500  shares  are  worth  $55,000. 

Of  this  $55,000,  $10,000  is  your  money  and  $45,000 

is  my  money.    You  have  made  $5000.    Suppose, 

now,  that  you  have  had  enough  for  the  present. 

You  have  vindicated  your  judgment  of  Atchison's 

value.    You  have  a  good  opinion  of  yourself.    You 

decide  to  rest  on  your  oars  and  take  your  profits. 

You  order  your  broker  to  sell.     Your  account 

with  your  broker  stands  like  this. 

15 


THE  CAREFUL  INVESTOR 

John  Jones  in  account  with  Smith  &  Company,  Bankers  and 
Brokers. 

Dr.  Cr. 

To  loan $45,000      By  500  shares  A.T.S.F.$55,ooo 

To  interest  I  month  6 

per  cent 225 

To  commission  ]/^  per 

cent 125 

$45,350 
Balance 9.650 

$55,000  $55,000 

The  broker  now  gives  you,  if  you  want  it,  a 
check  for  $9,650 — ^your  original  $5,000,  and  $4,650 
additional.  You  are  a  successful  speculator.  Life 
is  sweet. 

Now  reverse  the  situation.  Atchison  does  not 
go  up.  It  goes  down.  The  grasshopper,  or  the 
hot  winds,  or  the  Kansas  legislature,  or  the  Inter- 
state Commerce  Commission,  move  on  the  Atchi- 
son. Atchison  common  is  "weak."  It  goes  down 
two  points.  Comes  now  your  broker  and  says  to 
you,  in  effect,  something  like  this:  "You  own 
500  shares  of  Atchison.  These  shares  are  worth 
today  $49,000.  Of  this  $49,000,  $45,000  is  my 
money  and  $4,000  is  your  money."  Suppose  the 
hot  wind  blows  on,  and  Atchison  goes  down  three 

points  more.     Again  your  broker  confronts  you. 

16 


A  LAMB  IN  THE  STOCK  MARKET 

"Your  500  shares  are  worth  only  $47,500.  Of 
this  sum  $45,000  is  my  money  and  $2,500  is  your 
money.  I  have  these  shares  pledged  at  the  bank 
as  collateral  for  the  $45,000  I  borrowed  for  you. 
The  bank  demands  more  security.  I'm  sorry, 
but  I  must  have  more  margin.  About  $1,000  will 
be  sufficient. ' '  So  you  give  the  broker  $  i  ,000  more, 
and  if  Atchison  keeps  on  descending,  you  give  him 
another  $1,000,  and  another.  You  must  keep  his 
security  safe.  He  must  always  have  $45,000  in  the 
value  of  your  stock. 

Now,  suppose  you  cannot  meet  these  calls  for 
margin.  Suppose  Atchison  goes  down  10  points  in 
a  single  day — it  went  down  18  points  on  May  18, 
1 90 1 — and  you  cannot  raise  the  money  for  margins. 
You  are  sold  out.  Your  broker  sells  your  500 
shares  of  Atchison,  if  he  is  honest,  at  the  best  price  ■ 
he  can  get;  if  he  is  dishonest,  at  the  lowest  price 
of  the  day.    He  sends  you  this  statement : 

John  Jones  in  account  with  Smith  &  Company,  Bankers  and 

Brokers. 

Dr.  Cr. 

To  loan $45,000      By  500  shares  A.T.S.F. 

To  interest 225  ©92  $46,000 

To  commission 125 

Balance  due  Jones 650 

$46,000  $46,000 

2  17 


THE  CAREFUL  INVESTOR 

You  have  lost  $4,350,  perhaps  in  a  single  day. 
This  is  margin  speculation.  This  is  what  keeps 
the  stock  exchanges  and  the  brokers'  offices  going. 

There  are  two  questions  to  ask  about  specula- 
tion. First,  is  this  the  best  way  to  speculate?  and, 
second,  what  is  the  chance  of  profit  in  speculation  ? 
A  few  years  ago,  in  a  large  Eastern  city,  there  was 
a  stock  exchange  house  that  was  supposed  to  be 
impregnable.  The  partners  were  popular  and 
respected.  They  were  closely  related  to  two  of  the 
wealthiest  families  in  the  city.  The  firm  was 
reported  to  have  ample  capital.  One  morning 
this  firm  closed  its  doors.  Its  liabilities  were 
enormous.  Most  of  its  assets  had  disappeared. 
No  explanations  were  forthcoming.  The  creditors 
were  called  together  and  informed  that,  for  family 
reasons,  relatives  of  the  firm  would  make  up  most 
of  the  shortage,  provided  there  was  no  prosecution. 
Another  house  in  the  same  city  recently  failed.  It 
paid  to  unsecured  creditors  ten  cents  on  the  dollar. 

Cases  like  these  usually  involve  breaches  of 

trust  between  broker  and  client.     You  give  the 

broker  your  money  to  secure  him  in  borrowing  a 

much  larger  amount  of  money  with  which  to  buy 

500  shares  of  Atchison  stock  for  you.     You  leave 

the  stock  with  him  as  security  for  your  loan.     It 

18 


A  LAMB  IN  THE  STOCK  MARKET 

is  your  stock.  The  law  says  that  your  broker 
must  hold  it  for  you.  He  can  pledge  it  at  the 
bank,  but  he  must  pledge  it  for  your  benefit,  so 
that  whenever  you  want  to  pay  the  balance  due, 
you  can  have  the  stock.  If  your  broker  pledges 
this  stock  for  his  own  benefit,  or  in  any  way  puts 
it  out  of  his  power  to  deliver  you  these  500  shares 
when  you  come  for  them,  the  law  of  New  York 
and  Pennsylvania  says  he  is  guilty  of  larceny.  If 
your  broker  obeys  the  law  and  keeps  your  securi- 
ties for  you,  he  might,  indeed,  fail  in  business. 
His  own  funds  might  be  eaten  up  in  speculation 
for  his  own  account,  or  in  expenses,  but  his  failure 
would  disclose  no  "unsecured  creditors."  No  one 
would  lose  except  himself. 

When  you  deal  with  a  broker  on  this  basis  of 
depositing  margin,  you  depend  absolutely  upon  his 
good  faith  and  fear  of  the  law.  If  he  chooses  to 
use  for  his  own  benefit  the  stocks  which  belong  to 
you,  you  cannot  stop  him,  for,  as  long  as  he  re- 
mains solvent,  you  will  know  nothing  about  the 
matter.  There  is  no  inspection  of  brokerage  houses. 
They  are  all  partnerships.  There  is  no  bank  ex- 
aminer to  go  over  the  books.  The  customers  of 
brokerage  houses  are  absolutely  at  their  mercy. 

If  a  safe  method  of  margin  speculation  coiild  be 
19 


THE  CAREFUL  INVESTOR 

suggested,  surely  no  one  would  deal  through  the 
broker.  Yet  such  a  method  is  available  to  any- 
one with  a  substantial  bank  account.  If  you  have 
faith  in  the  Atchison;  if  you  believe  it  is  going 
up;  if  you  are  not  content  with  the  profits  on  50 
shares  which  you  have  the  money  to  buy  and  pay 
for;  if  you  want  the  profits  on  a  large  number  of 
shares, — go  to  your  banker.  Give  him  your  order. 
He  will  lend  you  80  per  cent  on  any  Atchison 
stock  which  you  may  own,  and  he  will  buy  the 
stock  for  you  through  some  broker,  charging  you 
only  the  broker's  commission.  You  cannot  buy 
as  many  shares  through  your  banker  as  through  a 
broker,  but  in  all  other  respects  the  transaction 
to  you  is  the  same  as  though  you  had  dealt  through 
the  "banker  and  broker." 

The  bank  buys  the  stock  for  you.  You  pay  the 
bank  $5,000.  You  sign  a  note  for  the  balance  of 
the  purchase  price.  It  is  your  stock.  The  certifi- 
cate is  made  out  in  your  name.  Your  note  is 
pinned  to  the  certificate,  and  it  goes  along  with  it. 
The  bank  does  not  use  your  stock  for  its  own 
purposes,  for  the  bank  is  a  public  institution,  a 
corporation  with  a  regular  organization.  What- 
ever it  does  must  be  known  to  the  officers  or  direc- 
tors.    Its  accounts  are  published.     It  is  subject 

20 


A  LAMB  IN  THE  STOCK  MARKET 

to  the  inspection  of  the  bank  examiners.  You 
know  that  when  you  buy  stock  on  margin  through 
your  bank  you  may  lose  your  money,  but  your 
loss  will  be  the  result  of  your  own  bad  judgment, 
and  not  of  the  larceny  of  a  broker. 

Since,  now,  as  speculators  in  stocks  on  margin, 
we  have  found  a  safe  way  to  speculate,  what  are 
our  chances  of  profit?  They  are  poor,  very  poor, 
almost  negligible.  Space  does  not  permit  at  this 
time  any  extended  discussion  of  the  reasons  why 
the  margin  speculator  has  no  chance.  Let  two 
cases  suffice  where  speculation  on  the  most  posi- 
tive information  went  wrong. 

Many  years  ago,  an  Eastern  railroad  was  in 
trouble.  It  was  a  large  producer  of  coal,  which  it 
sold  through  agents.  One  firm  of  agents  had  posi- 
tive information,  which  came  to  them  in  the 
course  of  business,  that  bankruptcy  was  inevitable. 
They  knew  it,  and  subsequent  events  proved  that 
they  were  right.  They  resolved  to  take  advantage 
of  this  knowledge  in  the  stock  market.  They 
raised  $30,000,  all  the  money  they  could  get  to- 
gether, and  they  sold  this  stock  short  on  a  10  point 
margin.  That  is  to  say,  they  made  a  contract 
through  their  brokers  with  certain  other  brokers 

to  lend  them  15,000  shares  of  this  stock,  and  they 

21 


THE  CAREFUL  INVESTOR 

agreed  to  deliver  15,000  shares  on  demand.  This 
stock  they  sold  for  $300,000,  leaving  the  $300,- 
000,  together  with  the  original  $30,000,  with  the 
broker  to  secure  the  transaction.  They  expected 
that  the  stock  would  drop  to  10.  Then  they  would 
order  the  broker  to  buy  15,000  shares,  which 
would  cost  only  $150,000;  return  the  shares  to  the 
brokers  from  whom  they  had  borrowed  them,  and 
receive  from  the  brokers  the  difference  between 
$300,000  and  $150,000,  less  the  brokers'  charges 
as  their  profit.  They  would  also  get  back  their 
original  stake  of  $30,000. 

Now,  observe.  The  information  was  accurate. 
The  railroad  company  was  in  a  bad  way.  It  did 
fail — later.  Its  stock  did  drop,  not  only  to  10  but 
to  5 — later.  At  the  time,  however,  certain  power- 
ful and  wealthy  men  decided  to  put  the  price  of 
this  stock  up,  and  by  heavy  buying  they  did  put 
it  up  to  25.  Our  friends  the  coal  dealers  were 
caught  in  the  rise.  Their  broker  was  asked  to 
return  the  15,000  shares.  He  bought  these  shares 
at  22,  costing  $330,000.  The  $30,000  was  gone. 
The  firm  failed,  and  it  was  no  comfort  to  them 
that  the  railroad  failed  soon  after. 

One  more  instance.  A  prominent  attorney  was 
employed  by  certain  stockholders  to  bring  suit  to 

22 


A  LAMB  IN  THE  STOCK  MARKET 

dissolve  a  large  company  whose  stock  was  active 
on  the  exchange.  The  announcement  of  the  suit 
was  sure,  as  he  thought,  to  break  the  price  of  the 
stock.  So  he  raised  $15,000  and  sold  the  stock 
short.  Now,  mark,  his  information  was  accurate. 
He  himself  had  drawn  the  papers.  He  himself  was 
to  file  them.  He  was  to  give  out  the  news.  The 
news  would  break  the  price  of  the  stock  at  least 
10  points.  He  was  certain  to  double  his  money. 
The  stock  was  sold  at  ten  o'clock,  immediately 
after  the  opening  of  the  exchange.  At  noon,  an- 
nouncement was  made  that  this  company  would 
be  merged  with  others  into  a  large  company.  The 
suit  was  withdrawn.  Immediately  the  stock  ad- 
vanced. The  lawyer  was  fortunate  to  escape  with 
the  loss  of  half  his  stake. 

Here  are  two  cases  where  shrewd  and  intelligent 
men,  "on  the  inside,"  possessed  of  accurate  and 
exclusive  information,  tried  to  turn  their  knowl- 
edge into  money  and  failed.  Such  cases  are  not 
exceptional.  The  wisest  speculator  this  country 
ever  produced  said  that  he  was  satisfied  to  be 
right  four  times  out  of  seven.  The  speculator  of 
average  intelligence  and  good  fortune  can  be  sure 
of  one  thing :    that  if  he  sticks  long  enough  at  the 

game,  he  will  lose  all  he  puts  in. 

23 


THE  CAREFUL  INVESTOR 

I  do  not  wish  to  be  understood  as  saying  that 
it  is  not  possible  to  buy  stocks  in  part  with  bor- 
rowed money  when  prices  are  low,  and  profit  by 
the  advance.  This  is  possible,  and  is  not  attended 
with  serious  risks  if  the  purchaser  is  careful  to 
maintain  large  margins  for  his  loans;  if  he  buys 
dividend-paying  stocks,  the  income  on  which  will 
offset  the  interest  on  his  loans ;  and  if  he  is  satis- 
fied to  wait.  I  do  not  believe  that  there  is  much 
risk  in  the  purchase  of  sound  railroad  stocks  on 
this  basis.  Eventually — it  may  be  after  the  lapse 
of  years,  but  some  day — the  purchase  will  prob- 
ably show  a  profit.  But  for  the  margin  specu- 
lator, for  the  trader  who  buys  and  sells  on  tips 
and  rumors,  who  is  in  and  out  of  this  or  that 
stock,  against  whom  6  per  cent,  interest  is  always 
running,  and  who  must  pay  $25  commission  on 
every  block  of  100  shares,  for  the  great  army 
of  the  "public,"  the  people  who  pay  the  brokers' 
bills,  who  keep  the  Stock  Exchanges  running, 
there  is  a  certainty  of  just  one  thing:  certain 
and  total  loss. 

A  broker  once  told  me  that  there  was  one  rule 
which  he  would  give,  if  he  dared,  to  his  customers, 
to  guide  them  in  selecting  stocks  for  trading  pur- 
poses.    "Take  a  piece  of  chewing  gum.     Reduce 

24 


A  LAMB  IN  THE  STOCK  MARKET 

it  to  an  adhesive  condition.  Mould  it  into  a  form 
convenient  for  throwing.  Throw  it  at  the  quota- 
tion board.  Buy  or  sell,  according  to  the  toss  of 
a  coin,  the  stock  indicated  by  the  spot  on  the 
board  to  which  the  chewing  gum  adheres.  Go  to 
Europe  for  three  months."  By  following  this 
advice,  he  said,  the  customer  would  have  a  chance 
— not  much  of  a  chance,  it  is  true,  but  some  chance. 
If,  however,  he  reads  the  financial  page  of  the 
newspaper,  and  listens  to  the  gossip  in  the  brokers' 
offices,  he  has  not  even  the  gambler's  chance,  since 
he  will  be  doing  exactly  what  the  powers  back  of 
the  market  want  him  to  do,  that  they  may  as 
quickly  as  possible  get  his  principal  before  it  is 
exhausted  by  the  constant  nibbling  of  the  broker. 

A  well-to-do  man  showed  his  ingenue  bride  a 
check  for  $  1 ,  800 .  "  Do  you  see  this  check  ?  Now, 
with  this  I'm  going  to  buy  sugar.  Sugar  is  going 
up,  and  I'll  give  you  the  profits."  Sugar  went 
down,  and  he  lost  his  $1,800.  The  lady  asked  for 
an  accounting.  "My  dear,  sugar  went  down. 
The  money  is  lost."  "And  you  haven't  any  sugar," 
she  asked  plaintively,  "not  even  any  sugar?" 

It  will  be  well  for  the  American  people  if  the 
present  dullness  in  brokerage  circles,  in  so  far  as 
this  dullness  represents  increasing  knowledge  of 

25 


THE  CAREFUL  INVESTOR 

the  pitfalls  of  margin  speculation,  shall  continue. 
For  money  making,  margin  speculation  is  worth- 
less.  As  a  means  to  loss  and  ruin,  it  has  no  rivals. 

So  much  for  the  traders.  What  now  of  the 
brokers?  Do  they  make  money,  and  how  much 
do  they  make? 

A  stock  brokerage  business  is  profitable  under 
ordinary  conditions  if  the  broker  does  not  trade  for 
his  own  accotint.  On  a  certain  mildly  active  day 
on  the  Philadelphia  Exchange — a  very  small  affair 
compared  with  the  New  York  Exchange — a  broker 
told  me  that  his  commissions  amounted  to  $750 
on  that  day's  business,  and  his  business  is  not  of 
the  first  rank,  even  for  Philadelphia.  If  only  the 
broker  will  keep  out  of  the  market  for  his  own 
account,  and  confine  himself  to  working  for  his 
"clients,"  he  is  pretty  sure  to  succeed. 

Providing  the  necessary  police  arrangements 
can  be  made,  all  branches  of  the  gambling  busi- 
ness, from  stuss  to  faro,  are  extraordinarily  prof- 
itable. Even  if  the  games  are  honestly  conducted, 
providing  only  that  the  house  has  ample  capital, 
the  returns  are  more  certain  than  in  any  other 
branch  of  pecuniary  activity.  But  when  the 
keeper  of  the  gambling  house  turns  gambler,  the 
testimony  is  unanimous  that  he  is  sure  to  lose. 

26 


A  LAMB  IN  THE  STOCK  MARKET 

So  in  the  stock  market  game,  in  which  more 
gambling  is  done  than  in  all  other  games  of  chance 
combined,  the  people  who  make  money  are  those 
who  keep  the  game,  who  take  their  percentage  in 
commissions  and  interest  on  every  transaction. 
The  players  in  this  game,  as  in  every  other  game 
of  chance,  are  sure  to  lose.  Surely  if  the  men  who 
live  in  daily  contact  with  the  security  market  can- 
not make  money  out  of  operations  in  stocks,  the 
outsider  has  even  less  chance  of  profit. 

But  what  of  the  study  of  "fundamental  condi- 
tions "  ?  If  we  study  crops,  earnings,  interest  rates, 
etc.,  can  we  not  make  money  in  stock  speculation? 
Is  it  not  a  fact  that  brokers  are  too  close  to  the 
market  to  take  proper  account  of  its  underlying 
tendencies?  Is  not  the  stock  market  far  different 
from  the  roulette  table?  Can  we  not  predict  from 
a  study,  say,  of  Reading  or  United  States  Steel, 
the  future  course  of  these  stocks,  and  make  money 
by  following  our  conclusions  with  our  money? 

Some  years  ago  a  wealthy  New  York  merchant 

retired  from  business.    His  fortune  ran  into  seven 

figures.     He  was  well  educated,   well  informed, 

studious.    He  enjoyed  a  wide  acquaintance  among 

bankers  and  business  men.     He  himself  was  a 

director  in  several  banks,   and  in  a  position  to 

27 


THE  CAREFUL  INVESTOR 

hear  the  latest  and  most  accurate  information 
affecting  security  values.  He  decided,  for  the 
remainder  of  his  active  life,  to  occupy  his  mind  in 
operations  in  stocks.  He  applied  to  this  business 
the  same  care  and  attention  that  had  brought  him 
his  fortune.  He  was  very  conservative.  He 
bought  only  after  a  careful  study  of  imderlying 
business  conditions,  as  well  as  of  the  circumstances 
of  the  particular  companies  in  which  he  was  inter- 
ested. He  had  ample  capital  to  follow  his  opera- 
tions to  a  conclusion.  For  seven  years  he  dealt  in 
stocks.  In  that  time  his  purchases  and  sales  totaled 
over  $12,000,000,  and  showed  a  profit  of  less  than 
$1,000  as  the  reward  for  large  capital  and  a  first- 
class  business  man  in  stock  speculation. 

My  behef,  based  on  a  somewhat  extended  ob- 
servation of  the  work  which  students  of  funda- 
mental conditions  are  doing,  is  that  what  I  have 
described  as  the  "chewing  gum"  method  of  specu- 
lation is,  in  the  long  run,  about  as  safe  as  specula- 
tion based  on  a  study  of  "underlying  conditions." 

Especially  is  the  studious  speculator  urged  to  do 
his  own  studying  and  to  avoid  the  professional 
stock-market  educators.  Every  one  knows  who 
they  are.  I  am  acquainted  with  several  of  them 
who  are  doing  very  well  indeed  in  selling  predic- 

28 


A  LAMB  IN  THE  STOCK  MARKET 

tions  based  on  "a  study  of  fundamental  condi- 
tions" to  persons  who  are  willing  to  pay  a  good 
price  each  month  for  the  "service."  For  thirty 
dollars  a  month,  you  can  have  daily  converse 
with  one  of  these  schoolmasters  who  will  tell  you 
when  and  what  to  buy  and  sell.  It  makes  little 
difference  in  the  final  result.  You  will  perhaps  lose 
your  money  in  less  time,  and  the  broker  will  get  less 
of  it  by  the  amount  you  pay  for  education.  Some 
of  these  students  have  lost  a  great  deal  of  money 
by  taking  the  advice  which  they  sold  to  others. 

I  do  not  believe  that  any  man,  or  any  committee 
or  congregation  of  men,  no  matter  how  well  in- 
formed, can  safely  advise  the  purchase  or  sale  on 
margin  of  speculative  securities.  Accurate  pre- 
dictions in  this  field  are  very  difficult.  Prices  are 
"made,"  to  a  large  extent,  on  the  stock  exchanges. 
Ask  your  broker,  if  you  can  find  him  in  a  confiden- 
tial mood,  whether  he  ever  "matches"  orders. 
Of  course  he  does.  When  a  pool  is  formed  to 
raise  the  price  of  a  stock,  orders  are  distributed 
both  to  buy  and  to  sell.  The  members  are  dealing, 
through  brokers,  with  one  another.  They  mark 
up  the  quotations,  hoping  to  attract  a  public  fol- 
lowing, who  will  take  the  stocks  they  have  accu- 
mulated off  their  hands  at  a  profit.     Sometimes 

29 


THE  CAREFUL  INVESTOR 

the  instructions  are  misunderstood,  and  the  game 
is  given  away  by  a  jump  of  thirty  points  in  Rock 
Island  in  half  an  hour.  In  that  case,  the  broker 
who  had  the  selling  order  was  snowbound,  or  sick,  or 
otherwise  unavailable,  and  when  the  buying  order 
was  executed,  there  was  no  stock  for  sale.  The 
Stock  Exchange  severely  disciplined  the  offenders. 

While  the  pool  is  working,  the  newspaper  men 
are  fed  with  news  calculated  to  help  along  the 
movement.  Rumors  that  "Frick  is  buying  into 
the  company,"  or  that  "the  Erie  will  purchase 
the  road,"  or  that  "a  conflict  for  control  of  the 
company  is  in  progress,"  are  passed  out,  and  some- 
times printed,  although  it  is  not  so  easy  as  it  once 
was  to  fool  the  financial  editor.  If  the  public  is 
attracted  and  buys  the  stocks,  the  pool  may 
change  to  the  bear  side  and  sell  short.  Then 
another  set  of  rumors  is  set  afloat.  "There  is 
friction  in  the  Union  Pacific  Board,"  "The  Harri- 
man  estate  is  selling  out  its  stock,"  etc.,  etc.  The 
president  of  a  large  Western  railroad  recently  said 
that  the  only  trouble  with  the  stock  of  his  com- 
pany was  the  "lie  factory  in  Wall  Street." 

I  do  not  wish  to  be  misunderstood.     Stocks  do 

rise   and   fall   from   certain  fundamental   causes. 

A  crop  failure,  for  example,  ought  to  produce  a 

30 


A  LAMB  IN  THE  STOCK  MARKET 

decline  in  the  stocks  of  railroads  located  in  the 
region  affected.  But  suppose  that  the  crop  failure 
comes  during  a  boom  year,  when  business  all  over 
the  country  is  expanding;  or  that  a  failure  in  the 
wheat  and  com  traffic  is  offset  by  a  rapid  growth 
in  oil  and  coal ;  or  that  the  company  has  been  very 
conservative  in  the  management  of  its  income, 
has  paid  out  in  dividends  only  half  its  earnings, 
and  now  makes  a  special  distribution  to  its  stock- 
holders. In  such  case,  crop  failure  might  be  more 
than  neutralized  by  the  favorable  influences,  and 
the  "scientific"  speculator  who  had  sold  "short" 
because,  after  a  careful  study  of  rain-fall  statis- 
tics, he  had  reached  the  correct  conclusion  that 
there  would  be  a  short  crop  in  the  south-west  and 
a  reduction  in  railroad  earnings,  might  lose  his 
entire  stake,  in  spite  of  correct  reasoning. 

Is  there  no  safe  method  of  speculating  on  margin  ? 
Cannot  a  man  with  $5,000,  for  example,  employ 
this  to  control  $50,000  of  stock,  so  that  if  the 
price  of  this  stock  advances  ten  points,  he  can 
double  his  money?  I  know  of  two  methods  which 
are  relatively  free  from  danger,  and  since  I  have 
said  so  much  against  margin  speculation,  these 
methods  ought  to  be  explained. 

In  recent  years  many  railroads  and  a  few  indus- 
31 


THE  CAREFUL  INVESTOR 

trial  corporations  have  been  issuing  a  security 
known  as  a  "  convertible  debenture. ' '  A  debenture 
bond  is  a  promise  of  a  corporation  to  pay  the  bearer 
or  registered  owner  $  1,000  in,  say,  1943.  Suppose 
the  company  has  $5,000,000  of  these  debentures 
outstanding,  on  which  it  pays  five  per  cent,  inter- 
est, or  $250,000  a  year.  The  company's  profits 
available  for  interest  payments  may  be  $1,000,000 
a  year.  In  such  a  case  the  debentures  would  be 
good.  They  would  usually  sell  between  90  and 
100  per  cent,  of  the  par  value,  sometimes  rising  to 
100  and  sometimes  falling  to  90. 

Now,  suppose  that  this  company,  needing  addi- 
tional funds,  decides  to  issue  $10,000,000  of  deben- 
tures in  place  of  this  $5,000,000,  providing  $5,000,- 
000  of  cash  and  retiring  the  old  issue  by  exchange. 
In  order  to  make  the  new  bonds  attractive,  they 
are  made  convertible  into  stock  at  par.  That  is 
to  say,  any  holder  of  a  $1,000  debenture  bond  can 
at  any  time  exchange  it  for  ten  shares  of  stock. 

Now  observe  what  happens.     If  the  company 

prospers,  and  raises  the  rate  of  dividend  on  its 

stock  from  6  per  cent,  to  12  per  cent.,  the  stock 

may  advance  from,  say,  90  to  175.     Since  the 

debenture  bonds  can  be  exchanged  at  par  for  the 

stock,  and  since  one  bond  equals  five  shares  of 

32 


A  LAMB  IN  THE  STOCK  MARKET 

stock,  the  value  of  the  debentures  will  follow  up- 
ward the  value  of  the  stock  for  which  they  can  be 
exchanged.  So  much  for  the  profit  side  of  the 
speculation.  Any  one  holding  the  bond  will  see 
it  rise  in  value  as  the  stock  rises. 

But,  as  we  have  seen,  there  is  a  loss  side  to 
speculation,  a  side  neariy  always  in  evidence.  And 
it  is  these  losses  which  speculation,  through  the 
purchase  of  convertible  debentures,  will  reduce  to 
a  minimum.  In  the  case  just  cited,  suppose  net 
earnings  fall  50  per  cent.,  due  to  an  industrial 
depression.  The  price  of  the  stock  purchased  at 
90,  when  a  6  per  cent,  dividend  was  paid,  might 
fall  to  45,  when  the  payment  of  dividends,  owing 
to  reduced  earnings,  was  suspended.  Suppose  now 
that,  with  $5,000  cash,  our  speculator  had  pur- 
chased 550  shares  on  a  10  per  cent,  margin.  In 
the  decline,  if  he  held  on  arid  did  not  sell,  his 
$5,000  would  soon  be  gone.  But  if  he  had  bought 
on  the  same  margin  50  convertible  debenture 
bonds  at  100,  he  might  have  a  chance. 

For  these  debentures  come  ahead  of  the  stock. 

Their  interest  must  be  paid  before  any  dividends 

are  paid.    A  decline  in  earnings  which  might  make 

it  necessary  to  pass  a  dividend  need  not  affect  the 

security  of  these  debentures.     They  might  not 
3  33 


THE  CAREFUL  INVESTOR 

fall  below  92.  The  speculator  who  held  them 
might  have  to  raise  another  $2,500  of  margin. 
He  might  be  forced  to  sell  a  part  of  his  holdings 
to  get  the  necessary  margin  to  protect  the  re- 
mainder, but  his  loss  need  not  be  total.  So  long 
as  interest  on  the  debentures  is  earned,  the  fear 
of  bankruptcy  to  follow  the  non-payment  of 
interest  will  constrain  the  directors  to  protect  the 
bonds.  So  the  price  of  the  debentures,  as  I  have 
said,  will  not  get  down  to  90,  although  the  stock 
might  fall  to  45  or  even  lower. 

Another  method  may  be  suggested  whereby  the 
spice  of  speculation  may  be  injected  into  the 
nourishing  but  less  appetizing  dish  of  investment. 
This  is  the  instalment  plan  of  purchasing  stocks. 
By  this  method,  assuming  that  in  three  years  you 
can  save  $15,000,  and  that  you  consider  a  certain 
stock,  Erie  2d  preferred,  for  example,  an  attractive 
purchase  at  40.  You  believe,  from  study  or  advice, 
that  within  three  years  Erie  2d  preferred  will  go 
to  $70  per  share.  You  want  to  profit  by  your 
conviction,  to  make  the  largest  possible  profit  con- 
sistent with  safety.  You  want  to  invest  in  Erie 
2d  preferred  on  margin,  but  you  do  not  want  to 
risk  the  loss  of  your  capital.  Assume  that  you 
have  $1,500  to  start  with,  and  that  you  can  save 

34 


A  LAMB  IN  THE  STOCK  MARKET 

$13,500  more  in  three  years,  at  the  rate  of  $375  a 
month.  You  make  a  contract  with  your  broker 
to  buy  375  shares  of  Erie  2d  preferred  at  $40  a 
share,  $1,500  down,  and  $375  a  month  for  36 
months.  When  the  broker  makes  this  contract 
with  you,  you  are  safe  against  being  sold  out,  so 
long  as  you  keep  your  agreement.  Erie  2d  pre- 
ferred may  drop  to  30  the  day  after  the  contract  is 
signed,  but  the  broker  must  hold  the  stock  for  you 
and  deliver  it  to  you  when  you  pay  $13,500,  either 
in  the  instalments  stipulated  or  in  larger  sums. 

Now  suppose  the  Goddess  of  Chance,  not  being 
able  to  get  at  you,  sheltered  behind  your  instal- 
ment contract,  to  do  you  harm,  turns  propitious 
and  Erie  goes  up  to  50  the  month  after  your  con- 
tract is  signed.  You  have  more  than  doubled 
your  money,  for  you  can  sell  your  375  shares  for 
$18,750,  pay  your  broker  the  $13,500  you  owe 
him,  plus  commission  and  interest,  and  have  about 
$3,500  in  place  of  your  original  $1,500.  If  this 
method  is  applied  to  the  purchase  of  dividend- 
paying  stocks  which  will  produce  an  income  to 
offset  the  interest,  stocks  which  have  a  solid  basis 
in  assets  and  earnings,  and  which  you  would  be 
glad  to  hold  as  permanent  investments,  there  is 

no  valid  criticism  to  be  made  against  it. 

35 


II 

STOCKS  OR  BONDS 

We  turn  now  from  the  subject  of  speculation, 
the  purchase  or  sale  of  securities  to  make  a  profit 
from  their  rise  or  fall,  to  the  subject  of  investment, 
the  purchase  of  securities  to  receive  the  interest 
or  dividends  which  they  pay,  and  the  first  question 
which  we  encounter  is  the  choice  of  securities. 
Shall  the  investor  buy  stocks  or  bonds  ? 

"Give  me  a  seat  in  the  front  row,"  said  an 
investor  to  his  banker.  ' '  No  stock,  no  real  estate, 
no  equities,  for  me.  I  do  not  want  to  look  over 
the  shoulders  of  the  audience.  I  want  the  front 
row.    Put  my  money  into  bonds." 

This  is  the  richest  nation  in  the  world,  and,  next 

to  France,  the  most  thrifty.    In  a  normal  year  the 

net  income  of  the  American  people,  after  paying 

most  liberal  living  expenses,  is  far  in  excess  of  their 

operating  expenses .   An  enormous  amount  remains 

for  investment.    What  becomes  of  this  money  ?   A 

large  amount  of  this  money  is  put  into  savings 

banks.     A  large  amount  goes  into  insurance.     A 

36 


STOCKS  OR  BONDS 

still  larger  sum  is  put  into  enterprises  of  various 
kinds  which  have  stock  for  sale.  Some  goes  into 
real  estate,  and  a  constantly  increasing  fraction 
into  bonds. 

It  has  been  estimated  that  on  the  average  a 
quarter  of  a  billion  dollars  a  year,  and  the  real 
figures  are  probably  higher,  is  lost  in  bad  invest- 
ments; sunk  in  margins  on  the  stock  exchange; 
donated  to  the  brood  of  mining  and  industrial 
schemes  whose  promises  are  gold,  and  whose  per- 
formances are  chaff  and  stubble ;  invested  in  town 
lots  in  some  "thriving  industrial  suburb " ;  or  even 
used  to  purchase  on  margin  standard  railway  and 
industrial  stocks,  which  seem  to  advance  only 
long  enough  to  inflict  heavy  losses  upon  those  who 
purchase  them  for  still  further  gains.  These  are 
the  vast  losses  in  the  game  of  business  hazard, 
where  the  dice  are  always  loaded  and  the  cards 
are  always  marked. 

On  the  other  hand  are  the  timid  ones,  who  buy 
the  obligations  of  the  government,  who  put  their 
money  into  savings  banks  or  into  life  insurance, 
whose  most  daring  flights  are  the  purchases  of  the 
homes  in  which  they  live.  These  are  recruited 
either  from  the  anaemic  or  the  dyspeptic,  or  from 
the  burnt  children  who,  as  a  result  of  sad  experi- 

37 


THE  CAREFUL  INVESTOR 

ence,  dread  the  fire.  Between  these  two  classes 
are  the  institutional  buyers  of  bonds;  the  insur- 
ance companies;  savings  and  commercial  banks, 
who  purchase  as  trustees  for  their  policy-holders 
and  depositors,  taking  a  liberal  toll  for  their  ser- 
vice ;  and  the  individual  bond-buyer,  the  man  who 
is  intelligent  enough  to  buy  his  investments  at 
first  hand,  and,  at  the  same  time,  sufficiently  con- 
servative to  decline  to  participate  in  the  risks  of 
business. 

"What  is  a  bond?  How  does  it  differ  from  a 
share  of  stock?  Why  does  it  offer  a  safer  place 
for  my  savings  than  a  savings  bank  or  a  trust 
company,  while  at  the  same  time  allowing  me  a 
moderate  share  in  the  profits  of  business?"  These 
are  questions  often  heard,  but  seldom  clearly 
answered. 

A  bond  is  a  promissory  note,  a  contract  to  pay 
money,  executed  and  issued  by  a  corporation, 
either  public  or  engaged  in  private  business,  and 
bearing  interest  at  4,  5,  or  6  per  cent.,  according 
to  the  location  of  the  borrowing  company  or  the 
business  in  which  the  corporation  is  engaged.  The 
payment  of  this  promissory  note  is  usually  secured, 
principal  and  interest,  by  a  second  agreement, 
executed  between  the  borrowing  company  and  a 

38 


STOCKS  OR  BONDS 

trustee  for  the  lender,  usually  a  trust  company, 
by  which  the  property  of  the  buyer  is  transferred 
to  the  trustee,  in  trust,  to  secure  the  punctual  per- 
formance by  the  corporation  of  all  its  agreements, 
including  not  merely  the  payment  of  interest  and 
of  principal  when  the  note  matures,  but  the  keep- 
ing of  the  property  in  good  repair,  and  the  per- 
formance of  many  other  covenants  which  increase 
the  safety  of  the  loan.  The  corporation  bond  is, 
therefore,  not  only  protected  like  any  other  prom- 
issory note  by  all  the  property  of  the  borrower 
which  can  be  sold  for  the  lender's  benefit  if  default 
is  made  on  either  interest  or  principal,  but  it  is 
safer  than  an  unsecured  promissory  note  in  that 
the  property  of  the  borrower  is  formally  set  aside 
as  security  for  the  loan.  The  borrowing  company 
can  neither  sell  the  property  nor  place  any  addi- 
tional incumbrance  upon  it,  nor  increase  the 
amount  of  its  indebtedness  secured  by  existing 
incumbrances,  without  the  consent  of  every  bond- 
holder, which  is,  of  course,  seldom  given. 

And  this  is  not  all.  If  only  the  bonds  of  "going 
concerns"  are  purchased — that  is,  the  bonds  of 
corporations  doing  a  profitable  and  increasingly 
prosperous  business — the  security  of  the  investor 

whose  bonds  are  protected  by  a  first  lien  on  all 

39 


THE  CAREFUL  INVESTOR 

the  property  of  the  corporation,  is  not  merely  the 
property  which  is  purchased  with  the  money  which 
he  pays  for  his  bonds,  and  which  he  is  safe  in  sup- 
posing will  earn  more  than  enough  to  pay  his 
interest,  but,  in  addition,  all  the  previously  exist- 
ing property  of  the  company.  In  other  words,  if 
the  investor  exercises  that  degree  of  care  in  the 
selection  of  his  bonds  which  any  prudent  man  will 
naturally  give  to  the  conduct  of  affairs  in  which 
he  is  interested,  both  his  principal  and  his  interest 
are  secured  and  secure. 

Now  contrast  the  position  of  the  corporation 
bond-holder,  the  creditor  of  the  company,  with 
the  position  of  the  stock-holder.  A  share  of  stock 
is  a  certificate  of  part  ownership  in  a  corporation. 
A  corporation  is  an  association  of  persons  to  which 
the  law  gives  the  right,  after  certain  simple  for- 
malities have  been  complied  with,  to  own  property, 
and  to  carry  on  certain  kinds  of  business.  It  is 
the  association  which  owns  the  property,  which 
borrows,  buys,  and  sells.  The  association  issues 
stock  which  represents  its  ownership,  in  exchange 
for  money  or  property. 

This  stock  is  divided  into  shares.    It  comes  into 

possession  of  those  who  expect  through  its  means 

to  share  in  the  profits  of  the  company.    The  stock- 

40 


STOCKS  OR  BONDS 

holder  is  the  owner  of  the  corporation,  as  the  cor- 
poration is  the  owner  of  the  property.  The  stock- 
holder does  not  own  any  part  of  the  factory,  or 
mine,  or  railroad.  He  owns  a  part  of  the  company, 
and  the  company  owns  the  property. 

As  the  stock-holder  does  not  own  the  property 
of  his  company,  so  he  does  not  manage  the  com- 
pany's business.  That  is  done  for  him  by  trustees 
called  directors,  whom  the  law  makes  him  elect. 
Each  share  of  stock  counts  as  one  vote  at  the  elec- 
tion, and  a  majority  of  the  stock  can  elect  the 
entire  board.  For  example,  a  corporation  capi- 
talized at  $10,000,000  may  have  100,000  shares  of 
stock.  An  investor  has  purchased  100  shares.  At 
the  election  he  has  100  votes  out  of  100,000,  or 
one  thousandth  part  of  the  total.  So  the  "right 
to  vote,"  which  is  one  of  the  privileges  of  the 
stock-holder,  not  enjoyed  by  the  bond-holder, 
amounts  to  little. 

The  small  stock-holders  in  the  best  managed, 
largest,  and  soundest  American  corporations,  either 
singly  or  in  combination,  have,  practically  speak- 
ing, no  influence  upon  the  election  of  directors. 
Where  the  officers  care  to  take  the  trouble  they  may 
send  out  proxies,  blank  powers  of  attorney  for 
stock-holders  to  sign,  but  in  only  the  most  excep- 

41 


THE  CAREFUL  INVESTOR 

tional  cases  can  an  individual  stock-holder,  who  has, 
in  theory,  the  same  right  to  solicit  proxies  as  the  offi- 
cers, gain  sufficient  support  to  influence  the  election. 

So  well  is  this  powerlessness  of  the  stock-holder 
recognized,  that  some  of  the  largest  railway  sys- 
tems in  the  United  States  are  dominated  down  to 
the  last  director  and  the  last  official  by  men  who 
own  only  a  few  shares  of  stock,  but  who,  in  case  of 
need,  can  secure  by  sending  out  requests  for 
proxies,  the  cooperation  of  a  sufficient  number  of 
stock-holders  to  enable  them  to  control  a  disputed 
election.  The  late  Henry  O.  Havemeyer,  who  was 
in  absolute  control  of  the  American  Sugar  Refin- 
ing Company  to  the  day  of  his  death,  held  about 
2/100  of  one  per  cent,  of  its  stock  when  he  passed 
away.  Elections  are  seldom  disputed.  Stock-holders 
are  too  widely  scattered  and  too  apathetic  to 
take  much  interest  in  the  way  their  company's 
affairs  are  conducted.  While  they  receive  divi- 
dends, they  are  content,  and  when  dividends  are 
reduced  or  suspended,  their  dissatisfaction  seldom 
rises  above  sleepy  growls  of  irritation  and  disgust. 

The  stock-holder  also  has  the  right  to  partici- 
pate in  profits,  when,  and  only  when,  these  are 
distributed  by  the  Board  of  Directors.     If  the 

profits  are  not  earned,  he  receives  no  dividends. 

42 


STOCKS  OR  BONDS 

Even  when  large  profits  have  been  earned,  he 
cannot  obtain  any  share  in  them,  unless  the  direc- 
tors declare  a  dividend,  and  there  is  no  power  to 
force  the  directors  to  take  such  action.  They  can 
decide  to  pile  up  profits,  and  the  stock-holders, 
unless  they  are  able  to  put  the  directors  out,  which 
seldom  happens,  are  helpless  to  interfere.  They 
own  shares  in  the  company,  it  is  true,  but  often 
this  does  them  little  good. 

Of  course,  there  is  a  brighter  side  to  the  picture. 
Sometimes  profits  are  very  large,  and  the  stock- 
holder gets  large  dividends,  but  he  must  always 
bear  in  mind  that  the  bond-holder's  interest  must 
first  be  paid,  and  that  any  losses  which  the  com- 
pany may  sustain  must  first  fall  upon  its  owners. 
And  how  numerous  those  losses  are!  Within  a 
few  months  in  1908,  the  United  States  plunged 
from  prosperity  into  depression,  and  down  went 
the  dividends  of  many  of  the  strongest  railroads 
and  industries ;  some  of  them  suspended  altogether, 
others  seriously  reduced. 

The  stock-holder  has  no  assurance,  moreover, 

that  the  amount  of  stock  outstanding  will  remain 

where  it  is.     He  may  be  called  upon  to  authorize  a 

doubling  of  the  capital  stock,  raising  the  number  of 

shares  from  100,000  to  200,000.     The  new  stock 

43 


THE  CAREFUL  INVESTOR 

may  be  issued  for  property  or  for  money,  and  the 
investment  may  be  profitable,  but  there  are  now 
twice  as  many  shares,  and  the  universal  practice 
of  increasing  stock  capital  keeps  down  the  dividend 
rates  of  even  the  most  prosperous  companies  to 
6  or  7  per  cent. 

It  is  a  hard  saying,  but  a  true  one,  that  the 
small  stock-holder  in  American  business  corpora- 
tions has  no  influence  in  selecting  the  directors, 
no  voice  in  the  management,  and  but  little  power 
to  protect  himself  against  the  directors  should 
they  decide  to  keep  him  out  of  his  profits  for  the 
purpose  of  depressing  the  value  of  his  holdings, 
so  that  they  may  purchase  it  from  him  at  low 
figures,  or  practice  upon  him  sundry  other  arts 
of  the  stock  manipulator.  He  is  powerless  to  pre- 
vent an  unlimited  increase  in  the  amount  of  stock, 
if  made  for  lawful  purposes  and  in  a  lawful  manner. 
He  has  no  claim  upon  the  company  to  pay  him 
dividends,  and  if  he  is  dissatisfied  with  the  way 
his  business  is  conducted,  his  only  remedy,  in  the 
language  of  a  famous  legal  decision,  is  either  "to 
elect  new  directors" — a  manifest  impossibility  for 
the  small  investor — or  ' '  to  sell  his  stock  and  with- 
draw," which  he  frequently  does  at  a  considerable 

discount  from  the  price  he  paid. 

44 


STOCKS  OR  BONDS 

How  different  and  how  vastly  superior  is  the 
position  of  the  investor  who  has  purchased  from 
reputable  and  responsible  bankers  the  mortgage 
bonds  of  the  same  enterprises  whose  stock-holders 
are  liable  to  so  many  hardships  and  mishaps.  In 
common  with  the  stock-buyer,  the  bond-buyer 
contributes  money  to  construct  and  extend  the 
plant  of  the  corporation.  They  are  both  inter- 
ested in  its  property  and  its  profits.  But  here  the 
resemblance  between  the  position  of  the  two  in- 
vestors abruptly  ends.  The  bond-holder  must  be 
paid  his  interest  regularly  or  the  company  becomes 
a  bankrupt.  The  stock-holder's  dividends  need 
not  be  paid  at  all,  unless  the  directors  so  decide, 
and  they  may  be  lowered  or  raised  at  the  directors' 
pleasure.    There  is  no  certainty  about  them. 

The  bond-holder  knows  that  his  money  has 

gone  into  some  kind  of  property — his  trustee  sees 

to  that.    The  stock  of  the  same  company  may  have 

been  originally  issued  for  the  "good-will" — often 

the  "good  will"  of  those  who  receive  the  stock. 

The  money  which  he  pays  very  often  goes  not  to 

the  company,  but  to  its  promoters,  and  those  who 

have  sold  property  to  it.     The  money  which  is 

paid  for  stock  takes  the  forms,  not  of  rails,  ties, 

and  power-houses,  but  of  automobiles,  horses  and 

45 


THE  CAREFUL  INVESTOR 

yachts.  The  bond-holder  does  not  own  any  part 
of  the  corporation,  as  does  the  stock-holder,  but, 
on  the  other  hand,  the  stock-holder  does  not  con- 
trol any  part  of  the  property,  while  all  the  prop- 
erty is  conveyed  to  a  trustee  for  the  safeguarding 
of  the  bond-holder's  interests.  The  bond-holder 
knows  how  much  of  a  particular  issue  he  owns,  and 
he  knows  that  the  total  amount  of  this  debt  may 
not  be  increased  unless  he  gives  his  consent. 
Before  the  stock-holder,  on  the  other  hand, 
stretches  an  endless  vista  of  new  issues,  whose 
amount  he  is  powerless  to  regulate  or  limit. 

The  bond-holder  has  a  first  claim  upon  earnings. 
In  very  few  cases  will  they  ever  fall  so  far  as  to 
endanger  his  interest.  Even  in  those  cases  where 
bonds  of  inferior  security,  or  which  have  been 
issued  in  excessive  amounts,  are  purchased  with- 
out proper  investigation,  from  bankers  who  valued 
immediate  profits  above  the  permanent  confidence 
of  satisfied  customers — and  most  of  these  bankers 
belong  to  a  past  generation — and  when  these  bonds 
have  been  in  default,  the  investor  has  seldom  suf- 
fered any  permanent  damage  if  he  has  held  on  to 
his  security.  These  companies  have  been  reorgan- 
ized; new  bonds  or  preferred  stock  are  issued  for 

the  bonds  in  default;  and,  in  the  great  majority 

46 


STOCKS  OR  BONDS 

of  cases,  all  the  losses  have  been  regained,  some- 
times with  a  large  profit.  The  stock-holder,  on 
the  other  hand,  takes  what  is  left  after  interest 
is  paid,  be  that  remainder  much  or  little.  He 
comes  after  the  bond-holder.  He  sits  in  the  lowest 
room,  eats  at  the  second  table,  occupies  a  seat  in 
the  back  row.  Long  before  the  bond-holder's 
interest  is  reached  by  the  decline  in  earnings,  the 
stock-holder's  dividends  are  suspended,  and  the 
reorganization  which  passes  lightly  over  the  credi- 
tors falls  upon  the  owners  with  crushing  force. 

As  a  final  difference  between  stock  and  bonds, 
the  value  of  a  first  mortgage  bond,  because  of  all 
the  advantages  and  points  of  superiority  which 
have  been  mentioned,  changes  very  little  in  com- 
parison with  the  value  of  the  stock  of  the  same 
company.  The  stocks  of  even  the  safest  and  best 
managed  companies  show  the  most  astonishing 
gyrations,  the  wildest  fluctuations.  They  fall 
$io,  $20,  $30,  $50,  a  share,  within  a  few  months, 
while  the  bonds,  securely  protected  by  their  posi- 
tion as  first  and  fixed  claimants  to  income,  rise 
and  fall  very  slowly  and  within  very  narrow  limits. 
The  owner  can  usually  be  certain  of  realizing  on 
his  investment  with  but  trifling  loss.     What  the 

stock-holder  will  get  may  depend  on  the  honesty 

47 


THE  CAREFUL  INVESTOR 

of  some  New  York  bank  president,  the  digestion 
of  a  high  government  officer  or  the  success  of  the 
advertising  campaign  of  some  stock-manipulator. 
Whether  to  sell  or  to  pledge  as  security  for  loans, 
bonds  are  conspicuously  better  than  stocks. 

Now,  then,  if  bonds  are  so  much  better  than 
stocks,  that  the  wayfaring  man,  if  not  altogether 
a  fool,  cannot  fail  to  appreciate  their  superiority, 
how  shall  bonds  be  bought?  Shall  the  investor 
turn  his  money  over  to  an  insurance  company  in 
an  "endowment"  policy,  or  to  a  savings  bank  or 
trust  company,  or  shall  he  buy  bonds  direct?  The 
answer  is  not  difficult.  It  is  his  money  which 
buys  the  bonds  in  any  event,  whether  he  deposits 
it  in  a  bank  or  pays  it  as  premiums  to  an  insur- 
ance company,  or  whether  he  chooses  the  better 
plan,  and  himself  buys  the  same  bonds  which 
these  institutions  purchase  with  the  money  which 
he  contributes. 

Why  should  he  not  buy  direct  and  obtain  the 
higher  interest  of  direct  ownership?  There  is 
only  one  objection  to  direct  bond-buying,  the 
lack  of  the  ability,  or  rather  the  lack  of  experience, 
of  the  private  investor  to  select  sound  investments. 
There  are  all  sorts  of  bonds,  good,  bad,  and  indif- 
ferently poor.     Great  care  and  much  intelligent 

48 


STOCKS  OR  BONDS 

investigation  is  required  to  choose  good  bonds  for 
investment.  The  insurance  companies  and  the 
savings  banks  pay  high  salaries  to  experienced 
men  to  make  investments  for  these  institutions. 
Their  depositors  and  policy-holders  reap  the  bene- 
fit in  perfect  security,  to  obtain  which  they  sacri- 
fice a  part  of  the  money  which  is  earned  on  the 
investment  of  their  money  by  these  institutions. 
The  investor  does  not  possess  this  ability.  Left 
to  himself  in  his  bond-buying,  he  may  go  badly 
astray.  Nor  can  he  afford  to  pay  adequate  fees 
to  expert  advisers. 

Into  this  situation  comes  the  bond-house,  with 
its  organization  of  experienced  investigators,  far 
superior  to  those  employed  by  the  insiu-ance  com- 
pany or  savings  bank,  its  large  capital  and  still 
larger  credit.  The  bond-house  buys  the  bonds  of 
enterprises  in  which  it  has  confidence  with  its  own 
money,  purchasing  them  not  as  a  broker  or  agent, 
but  as  an  investor,  and  then  resells  them  at  a 
small  profit  to  private  investors,  who  are  in  this 
way  able  to  purchase,  with  perfect  security  in 
both  interest  and  principal,  bonds  which  pay  them 
much  higher  returns  than  they  can  receive  from 
any  institution  to  which  they  may  entrust  their 
savings. 

4  49 


Ill 

THE     CORPORATION     MORTGAGE     AND 
THE  DEED  OF  TRUST 

Most  people  who  have  saved  money  are  ac- 
quainted with  the  nature  of  a  mortgage.  They 
understand  it  as  a  Hen  upon  property,  given  to 
secure  a  debt.  The  conditions  of  the  Hen  are  that, 
in  case  the  debt  is  not  paid  at  maturity,  the  lender 
who  holds  the  lien  can  force  a  sale  of  the  property 
by  judicial  process,  having  his  own  debt  paid  out 
of  the  proceeds,  and  returning  any  balance  to  the 
borrower. 

While  the  operation  and  effect  of  the  real-estate 
mortgage  are  generally  familiar,  the  nature  of  the 
Hen  conferred  by  the  mortgage  is  not  equally  well 
understood.  A  mortgage  is  a  conveyance  of  prop- 
erty by  the  owner  to  the  lender.  It  is  in  form  and 
in  effect  a  deed  similar  to  the  ordinary  deed  by 
which  property  is  conveyed  from  one  person  to 
another.  The  conveyance  is,  however,  coupled 
with  the  condition  that  the  creditor  holds  the  title 
to  the  property,  as  trustee  for  the  owner.  The 
conditions  of  the  trust  are  as  foUows.    If  the  debt 

50 


THE  CORPORATION  MORTGAGE 

to  secure  which  the  conveyance  is  made  is  not 
paid  at  maturity,  or  if  any  other  covenant  in  the 
mortgage  is  broken  by  the  lender,  the  trust,  which 
up  to  that  time  has  been  a  "passive  "  trust,  becomes 
active,  and  the  lender,  known  as  the  mortgagee, 
asserts  his  title  to  the  property  and  forces  its  sale. 
The  agreement  between  the  parties  binds  the 
borrower,  the  owner  of  the  property,  not  only  to 
the  payment  of  interest  and  principal,  but  also 
to  the  performance  of  certain  other  covenants  of 
great  importance  to  the  security  of  the  debt.  For 
example,  the  owner  must  insure  the  property  and 
make  the  policies  payable  to  the  lender;  he  must 
also  pay  the  taxes  and  deliver  the  tax  receipts  to 
the  holder  of  the  mortgage,  since  a  failure  to  pay 
taxes  might  result  in  a  sale  of  the  property  by  the 
State,  which  would  deprive  the  lender  of  his 
security.  The  borrower  agrees  to  keep  the  prop- 
erty in  good  repair.  He  further  agrees  not  to  sell 
any  portion  of  the  mortgaged  property  without 
the  consent  of  the  lender,  who  will,  of  course,  not 
allow  such  a  sale  to  be  made  unless  the  proceeds 
are  applied  either  to  the  liquidation  of  the  debt 
or  to  the  purchase  of  new  property  of  equal  value 
to  that  sold. 

^  This  mortgage  or  conditional  deed  which  con- 

51 


THE  CAREFUL  INVESTOR 

veys  the  title  to  real  property  to  the  lender  is  given 
to  secure  a  debt  in  the  form  of  a  bond.  This  bond 
is  a  simple  promise  to  pay  a  definite  sum  of  money, 
with  interest,  at  a  certain  date  in  the  future.  It 
is  signed  by  the  owner  of  the  property.  The  real- 
estate  mortgage  therefore  comprises  two  contracts : 
first,  a  contract  to  pay  money,  and,  second,  a  con- 
veyance of  real  estate  to  secure  the  fulfilment  of 
a  contract  to  pay  money. 

When  the  conveyance,  otherwise  known  as  the 
mortgage,  is  copied  into  a  book  of  record  kept  in 
a  public  office  for  the  inspection  of  all  those  who 
may  be  interested,  it  fixes  the  title  of  the  mortgage- 
holder  as  against  all  the  world.  The  owner  of  the 
property,  who  is  left  in  possession  so  long  as  he 
carries  out  his  agreements  with  the  lender,  is  free 
to  sell  his  interest  in  the  property.  He  must  sell 
it,  however,  subject  to  the  right  of  the  lender  to 
enforce  the  provisions  of  his  contract.  It  is  im- 
possible, in  any  other  way  than  by  a  tax  sale,  to 
separate  the  interest  of  the  lender  from  the  prop- 
erty to  which  that  interest  attaches. 

We  have  these  principles  carried  out  in  the 

corporation  mortgage  bond,  the  universal  form  of 

safe  investment.    There  is,  first,  a  promise  to  pay 

$1,000,000,   $5,000,000,   or  $100,000,000  in   ten, 

52 


THE  CORPORATION  MORTGAGE 

twenty,  or  fifty  years  from  date.  This  promise  to 
pay,  executed  by  the  officers  of  the  corporation, 
is  not  expressed  in  the  form  of  a  single  note,  but 
is  divided  into  1,000,  10,000,  or  100,000  notes, 
numbered  serially  from  one  to  the  total  number, 
and  all  identical  in  form,  with  the  single  difference 
in  the  numbers.  This  division  of  the  corporate 
debt  into  "pieces"  is  for  purposes  of  convenience 
in  marketing.  It  is  unusual  for  one  investor  to 
take  more  than  a  small  portion  of  a  large  loan. 
By  dividing  a  large  debt  into  a  number  of  identical 
notes,  each  of  small  denomination,  it  is  possible 
for  the  company  to  make  a  wide  distribution  of 
its  bonds  and  gather  funds  from  a  great  number  of 
private  investors  and  institutions. 

Just  as  the  corporation  bond  differs  but  slightly 
from  the  bonds  executed  in  connection  with  the 
real-estate  mortgage,  so  the  corporation  mortgage 
is  practically  identical  with  the  more  familiar  real- 
estate  mortgage.  Because  the  creditors  of  the  cor- 
poration are  numerous,  it  is  impossible  to  make 
the  conveyance  to  the  lenders — there  are  too  many 
lenders.  It  is  necessary,  therefore,  that  a  trustee 
should  be  appointed  to  act  for  the  lenders,  and  to 
hold  the  property  in  trust  for  the  securing  of  these 

various  obligations.    Sometimes  an  individual  trus- 

53 


THE  CAREFUL  INVESTOR 

tee  is  named  for  this  purpose.  The  usual  practice, 
however,  is  to  designate  a  trust  company,  which, 
because  of  its  large  capital,  and  its  administrative 
organization  experienced  in  the  conduct  of  matters 
of  this  kind,  makes  a  more  satisfactory  trustee  than 
an  individual.  A  corporation  mortgage  is,  there- 
fore, usually  known  as  a  deed  of  trust,  or  sometimes 
as  a  mortgage  deed  of  trust. 

The  form  of  the  corporation  deed  of  trust 
follows  the  usual  outline  of  real-estate  mortgages. 
There  is  first  a  description  of  the  bond  to  secure 
which  the  mortgage  is  executed.  Then  comes  the 
detailed  description  of  the  property.  This  prop- 
erty is  next  conveyed  to  the  trustee  in  a  form  of 
which  the  following  is  a  type : 

NOW,  THEREFORE,  THIS  INDENTURE  WITNESS- 
ETH that,  for  and  in  consideration  of  the  premises  and  of  the 
acceptance  of  the  refunding  bonds  by  the  holders  thereof,  and 
of  the  sum  of  one  hundred  dollars,  lawful  money  of  the  United 
States  of  America,  to  it  duly  paid  by  the  Trustee  at  or  before  the 
ensealing  and  delivery  of  these  presents,  the  receipt  whereof  is 
hereby  acknowledged,  and  for  other  good  and  valuable  considera- 
tions, Rogers-Brown  Iron  Company  has  granted,  bargained,  sold, 
aliened,  remised,  released,  conveyed,  confirmed,  assigned,  trans- 
ferred and  set  over,  and  by  these  presents  does  grant,  bargain, 
sell,  alien,  remise,  release,  convey,  confirm,  assign,  transfer  and 
set  over  unto  the  Trustee,  its  successors  in  the  trust  and  its  and 
their  assigns,  forever,  all  and  singular  the  following  described  or 
mentioned  property,  rights  and  franchises,  which  collectively  are 
hereinafter  generally  called  the  trust  estate,  to  wit: 

54 


THE  CORPORATION  MORTGAGE 

Then  follows  a  detailed  description  of  the  prop- 
erty, the  same  description  that  is  contained  in  the 
original  deeds  by  which  the  borrowing  and  pledging 
corporation  took  title  to  the  various  properties 
named  in  the  mortgage. 

The  nature  of  the  conveyance  is,  however,  not 
absolute,  but  conditional.  This  appears  in  the 
following  clause ;  respectively  called  the  Habendum 
Clause  and  the  Grant  in  Trust: 

TO  HAVE  AND  TO  HOLD  all  and  singular  the  said  prop- 
erty, rights  and  franchises  unto  the  Trustee,  its  successors  in  the 
trust  and  its  and  their  assigns,  forever: — 

IN  TRUST,  NEVERTHELESS,  for  the  equal  and  propor- 
tionate benefit  and  security  of  all  holders  and  registered  owners 
of  refunding  bonds  and  coupons  and,  .  .  .  for  the  enforce- 
ment of  the  pajtnent  of  the  principal  .  .  .  and  interest  of 
all  such  bonds  when  payable,  according  to  the  tenor,  purport  and 
effect  of  such  bonds  and  coupons,  and  to  secure  the  performance 
and  observance  of  and  compliance  with  the  covenants  and  condi- 
tions of  this  indenture,  without  preference,  priority,  or  distinction 
as  to  lien  or  otherwise  of  one  bond  over  any  other  bond  by  reason 
of  priority  in  the  issue,  sale  or  negotiation  thereof  .  .  .  and 
so  that  the  principal,  premium  and  interest  of  every  such  bond 
shall,  subject  to  the  terms  hereof,  be  equally  and  proportionately 
secured  hereby  as  if  all  had  been  duly  issued,  secured,  and  nego- 
tiated simultaneously  with  the  execution  and  delivery  hereof. 

Up  to  this  point,  there  is  no  substantial  differ- 
ence to  be  observed  between  the  wording  of  the 
real-estate  mortgage  and  the  wording  of  the  cor- 
porate mortgage.     The  only  points  of  variance  of 

55 


THE  CAREFUL  INVESTOR 

the  corporation  mortgage  are  the  greater  complex- 
ity, and  the  fact  that  in  the  corporation  mortgage 
the  conveyance  is  not  to  the  lender  direct,  but  to 
the  lender's  representative. 

From  this  point,  however,  the  corporate  mort- 
gage differs  from  the  real-estate  mortgage  in  that 
it  contains  a  variety  of  covenants  entered  into  by 
the  company  which  owns  the  property,  with  the 
trustee  who  holds  the  property  in  trust  for  the 
security  of  the  debt.  These  covenants  are  calcu- 
lated to  maintain  the  value  of  the  security. 

In  addition  to  a  repetition  of  the  agreements 
contained  in  the  bond  to  pay  principal  and  interest, 
the  company  which  owns  the  property  agrees  with 
the  trustee  in  the  mortgage  that  it  will  pay  the 
taxes ;  that  it  will  pay  all  claims  for  labor  and  ma- 
terials out  of  which  mechanic's  liens  might  arise, 
which  might  precede  the  claim  of  the  trustee  to  the 
property;  that  the  company  will  maintain  the 
property  in  good  condition  and  repair,  and  will 
continue  to  operate  the  property  in  the  conduct 
of  the  business  to  which  it  is  specifically  devoted, 
as,  for  example,  the  production  of  pig  iron  or 
the  business  of  transportation ;  that  any  property 
which  they  may  thereafter  acquire,  they  will,  by 

supplementary  deeds,  convey  to  the  trustee  as  ad- 

56 


THE  CORPORATION  MORTGAGE 

ditional  security  to  that  already  conveyed;  that 
they  will  not,  without  the  consent  of  the  trustee, 
sell  any  portion  of  the  property,  and  that  this 
consent  will  be  given  only  on  condition  that  the 
proceeds  of  the  sale  represent  a  fair  price  for 
the  property  disposed  of,  and  that  these  pro- 
ceeds are  invested  in  new  property  to  take  the 
place  of  that  withdrawn;  that  the  company  will 
keep  all  property  subject  to  the  danger  of  fire 
damage  fiilly  insured,  and  that,  if  the  trustee 
desires,  the  policies  of  insurance  shall  be  made 
payable  to  the  order  of  the  trustee,  so  that  the 
money  will  come  into  his  hands,  in  order  that  he 
may  superintend  its  disbursement;  that,  in  so  far 
as  the  company  operates  any  franchises  granted 
by  municipalities,  the  obligations  of  these  fran- 
chises will  be  faithfully  observed;  that,  in  so  far 
as  it  holds  any  property  imder  lease,  it  will  faith- 
fully carry  out  the  covenants  of  these  leases ;  and, 
in  general,  that  the  company  executing  the  mort- 
gage and  owning  the  property  will  carefully 
conserve  and  protect  the  physical  condition  and 
the  value  of  the  business  as  a  going  concern,  so 
that  the  bond-holders  may  have  at  all  times  ade- 
quate security  for  their  debt. 

The  mortgage  also  prescribes  the  method   of 
67 


THE  CAREFUL  INVESTOR 

enforcing  the  rights  of  the  bond-holders  in  case  of 
default  in  principal  or  interest,  or  the  breach  of 
any  other  covenant  in  the  mortgage.  In  such  an 
event,  the  trustee  is  sometimes  authorized  to 
seize  the  property  and  operate  it  for  the  benefit 
of  the  bond-holders,  or,  failing  in  this,  to  proceed 
in  the  manner  prescribed  by  law  to  have  the 
property  sold  and  the  proceeds  of  the  sale  applied 
to  the  liquidation  of  the  debt.  This  mortgage  is 
then  recorded  in  the  county  seat  of  every  county 
in  which  the  property  covered  by  the  mortgage 
may  be  located.  From  the  date  of  recording 
until  every  covenant  in  the  mortgage  has  been 
discharged,  the  bonds  of  the  company  are  pro- 
tected by  a  lien  upon  the  property  from  which 
this  property  can  in  no  way  be  released. 

It  has  been  noted  that  the  lien  of  the  mortgage 
has  been  treated  as  a  lien  upon  property.  In  the 
case  of  a  mortgage  given  by  a  business  corpora- 
tion, the  security  is,  however,  far  more  than  the 
physical  property.  This  physical  property  is  op- 
erated by  a  business  organization  which  often 
represents  the  result  of  many  years'  careful  work 
on  the  part  of  the  owners,  and  which  has  reached 
a  high  degree  of  efificiency.     Connected  with  the 

property  is  also  a  certain  amount  of  prestige  and 

58 


THE  CORPORATION  MORTGAGE 

good-will,  a  business  reputation  which  brings 
trade  and  increases  profits.  All  of  these  assets — 
physical  property,  business  organization,  good- 
will— together  represent  the  earning  power  of  the 
company,  its  ability  to  produce  a  profit.  In  these 
profits,  not  only  because  the  company  has  prom- 
ised to  pay  him  money,  but  because  that  promise 
to  pay  is  backed  up  by  a  conveyance  of  all  the 
physical  property  of  the  company,  the  bond- 
holder, after  the  claim  of  the  State  for  taxes,  has 
the  first  right  to  share. 

The  mortgage  bond-holder  is  more  than  a 
creditor  of  the  company.  His  rights  do  not  depend 
merely  upon  his  ability  to  sue  the  company  in 
case  of  default  in  principal  or  interest,  and  collect 
from  it  by  the  ordinary  process  of  law.  This 
right  to  sue  and  collect  is  a  valuable  one,  but  the 
mortgage  bond-holder  can  go  much  further  than 
this.  He  is  also  an  owner,  through  his  trustee,  of 
the  property  of  the  company.  He  has  an  interest 
in  that  property.  Although  that  interest  is  held 
in  trust  for  him,  yet  should  need  arise,  the  powers 
of  the  trust  can  be  asserted,  and  the  property  can 
be  seized  and  sold  for  his  benefit. 

It  is  this  feature  of  ownership  which  so  sharply 

distinguishes  the  position  of  the  stock-holder  from 

59 


THE  CAREFUL  INVESTOR 

that  of  the  mortgage  bond-holder.  The  stock- 
holder has  merely  an  interest  in  the  company.  He 
owns  no  property.  He  and  his  fellow  stock- 
holders, it  is  true,  own  the  company,  and  the  com- 
pany owns  the  property  subject  to  the  ownership 
of  the  bond-holder.  This  is  a  very  different  thing 
from  the  direct  ownership  of  the  property,  which 
is  enjoyed  by  the  bond-holder.  Through  his 
trustee,  the  bond-holder  actually  owns  the  prop- 
erty. The  claim  of  the  stock-holder  for  dividends 
is  contingent  not  merely  upon  these  dividends 
being  earned,  but  upon  the  decision  of  the  directors 
to  distribute  the  earnings  to  the  owners  of  the 
company.  With  the  bond-holder's  rights,  however, 
the  directors  can  take  no  liberties.  He  bears  a 
more  direct  relation  to  the  trust  estate  than  do 
the  stock-holders.  They  are  continued  in  posses- 
sion only  so  long  as  they  perform  the  covenants 
of  the  mortgage.  The  bond-holders  are  the  owners 
of  the  property,  and  they  will  assert  their  title 
through  the  trustee  if  the  company  does  not  faith- 
fully and  regularly  pay  them  their  interest. 


IV 

THE    BANKING    HOUSE    AS    AN    AID    TO 
INVESTORS 

The  plan  followed  by  the  conservative  invest- 
ment-banker in  offering  bonds  to  his  customers  is, 
first,  to  purchase  the  bonds  himself,  and  thus  to 
evidence  his  faith  in  their  soundness.  The  expres- 
sion "We  own  and  offer"  is  frequently  met  with 
in  bankers'  literature.  Before  purchasing  any 
bond  from  a  banking  house,  the  investor  should 
be  careful  to  ascertain  that  the  house  is  not  acting 
as  the  agent  or  representative  of  the  actual  owners. 

The  risk  which  the  banker  takes  is  not  so  great 
as  that  assumed  by  his  customer,  since  an  enter- 
prise may  be  entirely  sound  in  its  early  stages, 
when  its  bonds  are  sold  to  the  investor,  and  may 
be  afterwards  wrecked  by  bad  management.  This 
risk  the  banker  passes  on  to  his  customer.  The 
customer  must  rely  upon  the  banker's  anxiety  to 
maintain  the  good-will  of  his  business,  to  protect 
him  from  purchasing  unsound  securities. 

Notwithstanding  this  transference  of  the  risk, 
the  banker  must  assume  it  in  the  first  instance,  and 

61 


THE  CAREFUL  INVESTOR 

cases  are  not  lacking  where  large  issues  of  bonds 
have  been  purchased  with  the  idea  of  reselling 
them  to  the  investor,  but  which,  by  reason  of 
some  miscalculation  on  the  banker's  part,  could 
not  be  sold  at  a  profit  and  were  left  on  his  hands. 

Before  purchasing  any  issue  of  bonds,  therefore, 
the  conservative  investment-banker  will  provide 
for  a  careful  investigation  of  every  feature  of  the 
proposition  upon  the  basis  of  which  the  bonds  are 
issued. 

The  countless  disappointments  in  the  develop- 
ment of  new  enterprises  are  mainly  due  to  faulty 
investigation  as  to  the  possibilities  of  the  project, 
which  leads  to  wrong  conclusions  as  to  the  profits 
which  will  be  earned.  It  is  the  business  of  the 
banker  to  guard  against  these  mistakes.  The  con- 
sideration of  a  few  typical  cases  will  show  how 
serious  is  the  risk  of  the  investor  who  purchases 
securities  the  soundness  of  which  has  not  been 
determined  by  an  exhaustive  preliminary  inves- 
tigation. 

In  the  neighborhood  of  a  large  Eastern  city, 
there  is  a  suburban  electric  railroad,  running  out 
about  twelve  miles  from  a  terminal  station  at  the 
end  of  a  city  transportation  line,  through  a  num- 
ber of  fashionable  suburban  towns,  parallelling 

62 


THE  BANKING  HOUSE 

throughout  this  entire  distance  the  main  line  of  a 
large  and  well  managed  steam-railway  company, 
particularly  distinguished  for  the  excellence  of 
its  suburban  passenger  service.  The  syndicate 
which  promoted  this  enterprise,  and  which  com- 
pleted it  with  its  own  money — no  securities  being 
offered  to  the  public — employed  engineers  of  high 
reputation  and  sound  attainments  to  examine  into 
the  cost  and  anticipated  traffic  of  the  enterprise. 
The  line  was  surveyed,  estimates  were  made  of 
the  cost  of  obtaining  ground  for  a  right-of-way, 
and  arrangements  were  made  to  purchase  a  large 
amount  of  real  estate  for  the  development  of  sub- 
urban towns  which  would  furnish  traffic  to  the  line. 
The  engineers  then  addressed  themselves  to  the 
possibilities  of  traffic  for  the  new  line.  These 
engineers  had  obtained  their  experience  in  the 
West  where  the  interurban  electric  railway  has 
developed  in  competition  with  the  steam  roads, 
and  where  experience  has  shown  that  the  electric 
line  will  almost  invariably  draw  a  certain  per- 
centage of  the  traffic  of  the  steam  line,  which  will 
be  attracted  by  the  lower  rates  and  more  frequent 
service.  The  method  followed  in  the  West  in 
figuring  the  traffic  of  a  proposed  electric  line,  is 

carefully  to  estimate  the  traffic  of  the  steam  line 

63 


THE  CAREFUL  INVESTOR 

with  which  it  is  to  compete,  and  to  take  a  certain 
percentage  of  the  number  of  passengers  as  the  share 
of  the  electric  Hne,  adding  thereto  an  estimate  of 
the  new  traffic  which  the  electric  line  will  develop. 

In  the  case  under  examination,  the  engineers 
followed  this  method.  They  made  a  careful  com- 
putation of  the  traffic  at  each  of  the  stations  on 
the  line  of  railroad  which  their  line  was  to  parallel, 
and  from  this  estimate,  allowing  for  a  certain 
amount  of  new  business,  they  computed  the 
traffic  which  would  be  gained  by  the  suburban 
line.  Their  estimates  were  accepted  by  the  syndi- 
cate, and  over  three  million  dollars  was  provided 
for  construction  and  the  purchase  of  land. 

No  sooner  was  the  line  put  into  operation,  how- 
ever, than  it  was  found  that  the  engineers  had 
made  serious  blunders  in  their  calculations.  The 
people  of  the  towns  through  which  the  new  line 
ran  were  entirely  satisfied  with  the  service  fur- 
nished them  by  the  steam  line.  The  trains  were 
frequent  and  were  seldom  crowded.  Passengers 
were  delivered  at  a  station  in  the  centre  of  the 
city.  The  new  suburban  line,  on  the  other  hand, 
could  give  them  only  connection  with  the  city 
line,   necessitating  a  change  of  cars,   which  was 

inconvenient.    The  residents  of  these  towns  were, 

64 


THE  BANKING  HOUSE 

for  the  most  part,  well  to  do.  The  advantages  of 
saving  a  few  cents  in  their  fare  did  not  particularly 
appeal  to  them;  neither  did  the  more  frequent 
service  offered  by  the  electric  line  prove  much  of 
an  inducement,  since  the  bulk  of  the  traffic  was 
hauled  at  the  beginning  and  end  of  the  day.  As 
a  consequence,  the  traffic  of  the  new  line  proved  a 
sore  disappointment  to  the  promoters.  It  failed 
from  the  beginning  to  pay  its  fixed  charges,  and 
for  a  considerable  time  even  its  operating  expenses 
were  not  earned.  It  has  since  been  sold  at  less 
than  one-third  of  the  amount  of  money  invested 
in  its  construction;  an  expensive  extension  has 
been  built  to  make  it  profitable;  and  the  original 
syndicate  has  suffered  a  heavy  loss. 

Another  case  related  to  a  water-power  enter- 
prise in  a  Southern  State.  The  original  estimates 
of  the  cost  of  construction  in  this  case  were 
$1,900,000,  but  these  estimates  were  so  radically 
defective  that  when  the  project  was  about  half 
completed  the  money  was  exhausted.  The  prop- 
erty was  placed  in  the  hands  of  a  receiver,  who, 
on  the  basis  of  expert  engineering  investigation, 
estimated  that  over  $1,500,000  would  be  required 
to  complete  the  project.  The  promoting  syndi- 
cate was  forced  to  sell  the  half  completed  plant 
5  65 


THE  CAREFUL  INVESTOR 

at  a  heavy  sacrifice,  and  it  has  since  been  completed 
by  another  company. 

Mr.  H.  M.  Byllesby,  the  Chicago  engineer,  in 
a  recent  address  on  the  securities  of  water-power 
companies  as  investments,  mentions  the  following 
instance  as  an  example  of  the  great  danger  of 
underestimating  the  cost  of  new  enterprises :  "In 
developing  a  large  and  very  necessary  reservoir, 
they  made  some  soundings  (but  not  enough), 
they  dug  some  test  pits  (but  not  enough),  and 
located  what  they  believed  to  be  a  rock  ledge, 
upon  which  they  have  begun  to  build  a  dam  to 
impound  the  water  in  the  reservoir;  and  now, 
after  having  closed  the  door  for  the  raising  of 
further  funds,  they  find  themselves  in  an  extremely 
embarrassing  position,  because,  contrary  to  all 
geological  data  at  their  command,  contrary  to 
the  showing  of  their  test  pits,  this  ledge  of  rock, 
instead  of  drifting  uniformly  across  the  gorge 
where  the  dam  is  being  built,  has  developed  a 
'fault'  at  the  centre,  of  unknown  depth,  and  which 
can  only  be  bridged  over  or  made  safe  by  the 
expenditure  of  about  twenty-five  per  cent,  of  the 
cost  of  the  project.  If  it  were  not  for  the  fact 
that  the  men  back  of  this  enterprise  have  large 
individual  personal  means  and  ample  credit,  the 

66 


THE  BANKING  HOUSE 

raising  of  this  additional  money  .  .  .  would 
probably  force  this  particular  enterprise  to  a  dras- 
tic reorganization." 

In  cases  like  the  above,  and  they  are  numerous, 
mistakes  in  estimates  are  made,  some  unavoidable, 
but  most  of  which  could  have  been  prevented  by 
the  employment  of  good  engineers.  If  the  inves- 
tor buys  securities  offered  on  behalf  of  a  new  com- 
pany, he  is  almost  certain  to  buy  into  the  effects 
of  some  such  blunders  as  I  have  indicated.  The 
banking  house,  on  the  contrary,  takes  pains  to 
avoid  such  mistakes  by  making  an  investigation 
of  the  proposition,  an  investigation  so  thorough 
and  so  searching  that  no  important  defect  will  be 
left  undisclosed. 

The  following  is  an  outline  of  the  method  of 
investigation  employed  by  a  prominent  banking 
house  when  requested  to  purchase  an  issue  of 
corporation  securities: 

This  house  is  averse  to  purchasing  so-called 
"unseasoned"  or  construction  bonds.  An  enter- 
prise may  be  never  so  promising  in  prospect,  and 
yet,  if  it  has  no  established  record  of  earnings,  no 
balance  sheet  and  income  account  to  present,  if 
its  earnings  are  still  on  paper,  this  house  will  refuse 
to  have  anything  to  do  with  it. 

67 


THE  CAREFUL  INVESTOR 

New  enterprises  are  best  promoted  and  financed 
by  construction  syndicates.  Banking  houses  may 
take  an  interest  in  these  syndicates  as  promoters, 
expecting  to  make  a  portion  of  the  promoters' 
profits;  they  may  invite  some  of  their  own  cus- 
tomers into  the  syndicate,  not  as  investors,  but 
as  promoters  like  themselves;  but  they  will  take 
good  care  that  the  enterprise  has  passed  the  con- 
struction stage,  that  a  full  fiscal  year  has  been 
completed,  and  that  a  comfortable  margin  over 
interest  charges  is  shown  by  the  income  account, 
before  they  make  any  public  offering  of  the 
bonds. 

Even  when  bonds  are  seasoned,  however,  they 
will  not  be  offered  until  the  condition  of  the  com- 
pany issuing  them  has  been  subjected  to  an  ex- 
haustive analysis.  The  owners  are  first  requested 
to  submit  complete  data  regarding  the  company, 
which  are  analyzed  in  the  office  of  the  banking  con- 
cern. If  no  weakness  is  disclosed,  such,  for  exam- 
ple, as  stationary  population,  or  too  high  a  per- 
centage of  interest  charges  to  gross  earnings,  the 
formal  examination  begins.  First  comes  the  ex- 
amination of  the  engineer.  Only  expert  engineers 
of  long  experience  and  high  reputation,  men  quali- 
fied by  familiarity  with  corporations  of  the  class 

68 


THE  BANKING  HOUSE 

under  examination,  are  employed.  The  engineer's 
examination  goes  into  the  condition  of  the  prop- 
erty, the  character  of  the  management,  the  ade- 
quacy of  the  rates  charged  to  the  customers,  the 
relations  between  the  company  and  its  em- 
ployees, the  physical  value  of  the  corporation's 
property,  and  the  chances  of  growth  in  the  com- 
munity in  which  it  operates. 

Next  comes  the  audit  of  the  corporation's 
accounts.  Many  banking  houses  employ  their 
own  auditors  for  this  purpose.  In  the  absence  of 
such  a  skilled  employee,  they  rely  upon  the  advice 
of  outside  accountants  of  standing  and  experience. 
The  object  of  the  audit  is  to  see,  first,  that  the 
accounts  are  so  kept  that  they  show  the  actual 
condition  of  the  company,  and  second,  to  deter- 
mine whether,  for  example,  such  items  as  the  cost 
of  power  or  the  cost  of  maintenance  are  abnormally 
high. 

The  banking  house  also  insists  upon  a  careful 
legal  investigation.  This  relates  primarily  to  the 
franchises  under  which  the  company  is  given  the 
right,  for  a  term  of  years,  to  use  pubHc  property 
for  its  owTi  purposes.  The  banker's  attorney  will 
make  sure  that  these  franchises  are  sufficiently 
broad  for  the  purposes  of  the  company ;  that  they 

69 


THE  CAREFUL  INVESTOR 

do  not  impose  burdensome  restrictions;  that  they 
run  for  a  sufficient  time  to  enable  the  business  to 
be  properly  developed;  and  that  they  contain 
satisfactory  provisions  for  renewal  at  their  expira- 
tion. 

The  attorney  also  gives  much  thought  to  the 
preparation  of  the  mortgage  under  which  the 
property  of  the  company  is  conveyed  to  the  trustee 
for  the  securing  of  its  bonds.  The  mortgage  will 
set  forth,  in  great  detail,  the  property  which  is 
transferred.  It  will  bind  the  company  by  stringent 
provisions  to  maintain  the  value  of  this  security 
intact,  and  it  will  carefully  limit  and  safeguard 
the  future  issues  of  bonds  secured  by  the  same 
mortgage,  so  that  a  large  margin  of  security  in 
the  cost  of  the  property  will  be  assured  to  the 
bond-holders. 

If,  after  this  investigation,  the  banker  is  con- 
vinced that  the  bonds  are  safe,  and  that  their 
safety  will  so  increase  that  any  one  buying  these 
bonds  will  be  assured  of  a  fixed  income  for  a 
term  of  years,  and  the  return  of  his  principal 
at  the  end  of  the  term,  the  banker  will  pur- 
chase the  bonds,  and  will  then  offer  them  to  his 
customers. 

The  investor  has  none  of  the  equipment  for 
70 


THE  BANKING  HOUSE 

making  an  investigation  of  this  kind.  If  he  relies 
upon  the  representations  of  the  promoters  of  any 
scheme,  he  is  almost  certain  to  be  misled.  If  he 
attempts  to  investigate  the  proposition  for  him- 
self, his  failure  is  likely  to  be  both  ludicrous  and 
lamentable.  If,  however,  he  relies  upon  the 
recommendations  of  a  banking  house  of  standing, 
there  is  little  chance  of  his  losing  his  money. 


THE    BUSINESS    OF    THE    INVESTMENT- 
BANKER 

In  the  field  of  security  investments,  the  buyer 
should  seek  information  on  three  points:  (i) 
Shall  I  purchase  stocks  or  bonds  ?  (2)  From  whom 
shall  I  purchase  my  securities?  (3)  In  what  in- 
dustries shall  I  invest?  The  first  question  was 
answered  in  the  last  chapter.  We  have  now  to 
take  up  the  second  question:  From  whom  shall 
I  purchase  my  bonds? 

The  security  business,  in  its  organization,  re- 
sembles any  other  business.  There  are  the  manu- 
facturers, the  companies  which  issue  the  bonds; 
the  distributors — in  vestment -bankers,  investment 
or  finance  companies,  savings-bank  and  insurance 
companies,  which  purchase  bonds  from  the  pro- 
ducers, and,  directly  or  indirectly,  place  them  in 
the  hands  of  the  consumer;  and  finally  the  con- 
sumer, the  investor,  the  policy-holder,  or  the 
savings-bank  depositor.  In  the  field  of  merchan- 
dise distribution,  there  are  some  producers  who 

deal  directly  with  the  consumer,  but  these  are  the 

72 


THE  INVESTMENT-BANKER 

exceptions.  Generally  speaking,  the  producers  of 
shoes,  hats,  groceries,  and  dry  goods  have  found  it 
economical,  and  in  all  other  ways  satisfactory,  to 
deal  with  the  wholesaler.  The  jobber  will  buy  in 
round  lots  from  the  manufacturer,  taking  his 
entire  season's  output  of  a  certain  Hne,  assuring 
him  his  money  without  risk  or  trouble  of  collec- 
tion, and  enabling  him  to  make  his  financial  and 
industrial  plans  on  a  basis  of  assured  receipts. 

It  is  even  more  advantageous  for  the  manu- 
facturer of  bonds,  the  borrowing  company,  to  deal 
with  the  bond-jobber,  the  investment-banker. 
The  investment-banker  is  in  most  cases  a  partner- 
ship. If  of  the  first  rank,  the  concern  will  have  a 
large  capital,  and  a  credit  with  banks  and  trust 
companies  several  times  the  amount  of  its  capital. 
The  investment-banker  will  also  have  associations 
with  other  houses  of  the  same  kind,  which  will 
place  at  his  disposal  large  sums  of  cash  whenever  he 
requires.  The  business  of  the  investment-banker 
is  the  purchase  and  sale  of  securities.  He  some- 
times adds  to  this  other  functions  similar  to  those 
performed  by  a  commercial  bank,  such  as  receiving 
deposits  subject  to  check,  and  the  purchase  and  sale 
of  bills  of  foreign  exchange.     His  main  business, 

however,  is  dealing  in  investment  securities. 

73 


THE  CAREFUL  INVESTOR 

The  investment-banker,  the  jobber  of  bonds, 
organizes  his  business  on  the  Hnes  of  a  hardware 
or  drygoods  jobber.  He  has  in  his  files  the  names 
of  a  large  number,  sometimes  many  thousands,  of 
present,  prospective,  or  potential  customers.  He 
knows  about  how  much  money  each  has  to  invest, 
and  the  approximate  dates  when  this  money  is 
available.  He  has  an  organization  of  salesmen 
who  visit  these  customers,  impressing  upon  them 
the  merits  of  the  securities  offered  by  their  house. 
The  work  of  the  salesmen  is  supplemented  by 
letters,  circulars,  and  public  advertising.  Some 
of  the  large  houses  extend  their  operations  to 
foreign  countries.  They  can  draw  upon  the  invest- 
ment resources  of  France,  Holland,  England,  and 
Germany.  The  investment-banker  sells  largely  to 
institutions — insurance  companies,  trust  compa- 
nies, state  and  national  banks. 

These  security  jobbers  stand  ready  to  purchase 
for  cash  the  bonds  and  sometimes  the  stocks  of 
corporations  and  municipalities.  The  prices  which 
they  offer  the  corporation  are,  of  course,  below  the 
prices  which  they  expect  to  receive — four  points 
on  some  bonds,  ten  points  on  others.  Out  of  the 
difference  they  pay  their  expenses  and  make  their 
profit.    It  is  nearly  always  advantageous  for  both 

74 


THE  INVESTMENT-BANKER 

the  security  producer  (the  corporation)  and  the 
security  consumer  (the  investor)  to  deal  with  the 
security  jobber. 

To  the  corporation,  the  advantage  of  dealing 
with  the  investment-banker  are  evident.  To  begin 
with,  when  the  contract  with  the  banker  is  signed, 
the  cost  to  the  corporation  of  obtaining  the  money 
which  it  requires  is  determined.  The  bonds  may 
be  sold  at  8s,  8 7>^,  or  95-  No  matter  what  the 
price,  the  cost  of  the  money  is  kno\vTi.  This  money 
will  be  paid  over  to  the  corporation  either  at  defi- 
nite dates  or  on  demand.  Contracts  can  be  made 
for  cars,  or  locomotives,  or  bridge  material,  with 
absolute  certainty  that  the  money  to  pay  the  bills 
will  be  in  hand. 

The  cost  to  the  corporation  of  selling  securities 
direct  to  investment-jobbers  is  usually  much  less 
than  the  cost  by  the  alternative  method  of  direct 
sale  to  the  investor.  The  certainty  of  return, 
moreover,  is  far  greater.  The  banker  has  a  per- 
manent organization  and  an  established  clientele 
of  customers.  The  organization  is  constantly  at 
work  marketing  bonds  and  many  of  the  customers 
are  steadily  buying.  Most  of  the  older  houses 
control  the  security  trade  of  a  large  part  of  their 
clientele  who  will  buy  from  no  one  else.     The 

76 


THE  CAREFUL  INVESTOR 

investment-banker  can  count  on  a  certain  amount 
of  money  from  these  customers  at  regular  intervals. 

It  is  not  necessary  for  the  banker  to  force  his 
bonds  on  an  unwilling  market.  By  utilizing  his 
credit,  the  banker  can  usually  borrow  up  to  80  per 
cent,  of  the  cost  of  these  securities  which  they 
have  purchased. 

An  established  banking-house  can  also  employ 
the  method  of  trading  a  new  issue  for  an  old.  Their 
regular  customers,  upon  whom  the  bankers  can  rely 
to  buy  their  quota  of  any  new  issue,  may  have 
purchased  all  the  bonds  they  can  pay  for.  They 
have,  however,  old  bonds  with  established  records 
of  interest  payments,  so-called  "seasoned"  bonds, 
which  are  readily  salable.  The  bonds  of  the  new 
issue  are  now  exchanged  for  the  "seasoned"  bonds 
on  terms  which  show  a  profit  to  the  holder  of  the 
old  bonds.  For  example,  he  is  allowed  to  buy  a 
$1,000  bond  which  would  cost  him  $950  in  cash 
for  $950  in  old  bonds.  The  old  bonds  thus  acquired 
by  the  bankers  can  be  sold  perhaps  for  97,  although 
they  might  have  difficulty  in  selling  the  new  bonds 
at  93. 

Finally,  the  investment-banker  has  the  great 

advantage  of  associations  in  the  same  line  of  trade. 

Unlike  the  merchandise  jobber,  he  has  developed 

76 


THE  INVESTMENT-BANKER 

to  a  high  degree  the  methods  of  cooperative  buy- 
ing. When  a  new  issue  of  bonds  is  to  be  purchased, 
he  can  quickly  form  a  purchasing  syndicate  con- 
taining perhaps  twenty  other  houses,  located  in 
all  parts  of  the  country.  He  has  thus  at  his  dis- 
posal twenty  selling  organizations  and  groups  of 
investors  in  addition  to  his  own. 

Sharply  contrasted  with  the  superior  advantages 
of  the  investment-banker  as  a  distributor  of  securi- 
ties, is  the  situation  of  the  corporation  which  tries 
to  do  this  work  for  itself.  A  corporation  engaged 
in  the  mining  of  coal  or  the  operation  of  an  electric 
railway  does  not  possess  any  of  the  elaborate  equip- 
ment necessary  for  the  sale  of  large  amounts  of 
securities  on  short  notice.  Since  its  demands  for 
new  capital  are  occasional,  dependent  upon  its 
need  for  larger  facilities,  a  company  may  run  along 
for  five  or  six  years  without  selling  any  securities. 
There  would  be  no  occupation  for  a  securities 
selling  department  under  these  circumstances. 
Any  company,  even  a  strong  corporation,  desiring 
to  sell  bonds  outside  the  circle  of  its  own  stock- 
holders must  construct  a  special  organization  for 
the  purpose  and  at  the  time.  Such  an  organiza- 
tion is  expensive  and  inefficient.  The  company 
must  rely  on  newspaper  advertising  to  discover 

77 


THE  CAREFUL  INVESTOR 

its  prospective  customers,  and  this  is  a  very  ex- 
pensive method. 

Again,  most  companies  have  difficulty  in  bor- 
rowing from  banks  on  the  security  of  their  own 
bonds,  although  the  same  security  may  be  entirely 
satisfactory  to  the  same  banks  when  offered  by 
the  investment-banker.  The  cost  of  selling,  and 
the  proceeds  of  sale,  under  these  conditions,  would 
be  equally  uncertain.  The  corporation  could  not 
launch  any  extensive  building  programme,  while 
relying  upon  so  precarious  a  source  from  which  to 
meet  its  contract  obligations. 

So  important  and  so  plain  are  the  advantages 
of  selling  bonds  to  bankers  instead  of  attempting 
to  reach  the  investor  direct,  that  the  method  of 
direct  appeal  is  adopted  only  when  necessity  con- 
strains. The  manufacturer  of  shoes  may  decide 
to  do  without  the  jobber,  and  may  establish  his 
own  chain  of  stores  through  which  he  may  market 
his  product  direct.  The  wisdom  of  this  method 
is  doubtful  as  a  general  practice,  but  in  a  few  cases 
it  has  undoubtedly  succeeded.  But  the  shoe- 
manufacturer  is  making  shoes  all  the  time.  His 
factory  runs  continuously,  if  he  can  sell  its  output. 
His  business  is  to  manufacture  and  to  sell  shoes. 

The  manufacturer  of  railroad  securities,  how- 

78 


THE  INVESTMENT-BANKER 

ever,  only  starts  this  portion  of  his  productive 
machiner}'  running  when  he  needs  money  to  build 
a  new  line,  or  to  reduce  grades,  or  to  excavate 
tunnels,  in  order  to  reduce  the  cost  of  train  move- 
ment. His  business  is  to  transport  passengers 
and  freight,  not  to  make  pig  iron  or  cotton  cloth. 
The  raising  of  new  capital  by  the  sale  of  bonds  or 
stocks  is  incidental  and  contributory  to  his  main 
business.  It  is  difficult  to  imagine  a  situation 
where  it  will  be  advantageous  for  a  corporation, 
unless  its  own  stock-holders  are  able  to  supply 
its  need  for  new  money,  to  ofifer  its  securities 
direct. 

The  conclusion,  from  the  standpoint  of  the 
investor's  interest,  is  plain.  Whenever  the  invest- 
ment-banker will  buy,  the  corporation  with  bonds 
for  sale  will  sell  them  to  the  investment-banker. 
Only  when  the  banker  will  not  purchase,  or,  as 
shown  above,  when  the  stock-holders  of  the  com- 
pany desiring  to  raise  new  capital  are  willing  to 
add  to  their  investment,  \\411  any  other  method 
than  sale  to  the  investment-banker  be  adopted. 
If,  now,  we  find  that  the  investment-banker  -will 
buy  only  the  best  bonds  for  sale  to  his  clients,  it 
is  a  safe  conclusion  that  if  the  investor  wishes  good 
securities,  he  can  rely  upon  getting  them  nowhere 

79 


THE  CAREFUL  INVESTOR 

else  than  from  the  bankers  whose  business  it  is 
to  .select  such  securities  and  to  sell  them. 

A  moment's  consideration  of  the  case  will  suffice 
to  show  that  the  success  of  the  investment-banker 
depends  upon  the  quahty  of  the  bonds  which  he 
offers  for  sale.  He  expects  his  business  to  be  per- 
manent with  every  client.  When  a  man  has  saved 
$i,ooo  and  purchased  a  bond,  it  is  a  reasonable 
presumption,  from  the  banker's  standpoint,  that 
he  will  repeat  the  operation  many  times,  and  the 
banker  intends  that,  as  far  as  possible,  he  shall 
supply  the  investments  for  the  succeeding  thou- 
sands also.  Again,  if  the  banker  sells  a  bond 
maturing  in  ten  or  twenty  years,  he  has  a  record 
of  that  sale,  and  when  the  bond  is  paid  off  he 
expects  to  have  a  new  bond  ready  to  take  the  place 
of  the  old  one.  He  aims  to  cultivate,  therefore, 
by  every  means  in  his  power,  the  good-will  of  his 
customers.  The  number  of  investors,  considered 
in  relation  to  the  total  population,  is  small.  Com- 
petition for  their  money  is  very  keen.  When  once 
a  prospect  has  been  converted  into  a  customer,  the 
banker  has  the  strongest  possible  motives  of  self- 
interest  to  keep  him  for  a  permanent  customer. 

The  basis  of  the  customer's  good-will,  the  foun- 
dation upon  which  a  large  security-selling  business 

80 


THE  INVESTMENT-BANKER 

must  be  erected,  is  the  high  quality,  the  impreg- 
nable security,  of  the  bonds  which  the  banking- 
house  offers  for  sale.  In  his  literature,  in  his 
advertisements,  and  through  his  salesmen,  the 
banker  lays  strenuous  emphasis  upon  the  safety 
of  his  wares.  He  recommends  them  to  his  cus- 
tomers. Usually  he  has  bought  them  for  himself 
before  he  offers  them  for  sale.  His  constant  en- 
deavor is  to  protect  his  customers  against  loss. 
He  will  carry  this  solicitude  for  the  customers' 
good-will  so  far,  in  some  cases,  as  to  repurchase 
bonds  concerning  whose  value  questions  may  have 
been  raised,  or  whose  reputation  has  been  blown 
upon.  He  has  been  known  to  undertake,  at  his 
own  risk,  the  work  of  reorganizing  bankrupt  com- 
panies whose  bonds  have  passed  through  his  hands, 
so  that  they  may,  without  loss  to  the  creditors, 
be  started  anew. 

A  man  in  such  a  business  cannot  afford  to 
recommend  to  his  customers  bonds  concerning 
whose  soundness  there  may  be  any  question.  To 
depart  from  this  rule  means  the  ultimate  destruc- 
tion of  his  business.  He  may,  as  some  bankers 
have  done,  sell  a  large  amount  of  doubtful  bonds 
or  stocks  during  a  period  of  business  prosperity, 
when  all  enterprises,  both  bad  and  good,  were 
6  81 


THE  CAREFUL  INVESTOR 

making  money.  He  may  trade  upon  the  con- 
fidence of  his  clients  and  temporarily  enrich  him- 
self at  their  expense.  But  when  a  business  depres- 
sion overtakes  these  shaky  enterprises  which  he 
has  financed  they  go  down  in  ruin,  and  with 
them  goes  the  good-will  of  the  banker's  business. 
We  arrive,  then,  at  this  conclusion:  since  it  is 
to  the  interest  of  corporations  having  bonds  for 
sale  to  sell  them  through  investment-bankers,  and 
since  it  is  to  the  interest  of  the  investment-banker 
to  purchase  only  safe  bonds,  it  follows  that  safe 
bonds  of  new  companies,  those  which  are  offered 
at  attractive  prices,  can  be  purchased,  as  a  rule, 
only  through  the  investment-banker. 


VI 
THE     RELIABLE     INVESTMENT-BANKER 

The  question  is  often  asked,  Does  the  invest- 
ment-banker guarantee  the  securities  that  he  sells  ? 
His  literature  abounds  with  assurances  that  any 
one  who  purchases  his  wares  will  not  lose.  The 
investment-banker,  by  his  own  representations, 
deals  in  securities.  Whoever  intrusts  his  money  to 
him  may  sleep  soundly,  undisturbed  by  fears  of 
loss.  These  representations  are,  moreover,  true. 
Only  a  small,  almost  negligible  fraction  of  the 
bonds  placed  through  banking-houses  of  the  first 
class  are  ever  in  trouble. 

Still,  losses  and  defaults  sometimes  occur.  I 
have  before  me  a  circular  letter  addressed  to  the 
bond-holders  of  a  manufacturing  concern,  now  in 
receivers'  hands,  by  a  protective  committee,  in- 
viting deposit  of  bonds  for  mutual  defense  and 
protection.  The  St.  Louis  and  San  Francisco 
bond-holders  are  making  similar  appeals.  Such 
cases  of  default  are  fortunately  rare.  They  do 
occur,  however,  and  the  investor  who  is  thinking 
about  the  purchase  of  bonds  will  do  well  to  have 

83 


THE  CAREFUL  INVESTOR 

them  in  mind.  By  electing  to  take  a  bond  rather 
than  a  share  of  stock,  the  investor  has  abandoned 
all  claim  to  share  in  the  profits  of  the  business 
above  the  five  or  six  per  cent,  which  will  be  paid 
to  him  as  interest.  He  has  decided  to  choose  safety 
of  principal  and  a  fixed  income.  He  wishes  some 
guarantee  and  assurance  that  his  principal  will  be 
safe  and  his  income  secure.  Can  the  investment- 
banker  give  him  this  assurance? 

On  some  points  the  investor  can  feel  satisfied, 
provided  he  deals  only  with  banking-houses  of 
proved  reputation.  He  can  be  sure  that,  barring 
the  "acts  of  God  and  the  pubHc  enemy,"  his 
investment  will  be  safe,  that  his  interest  will  be 
paid  him  regulariy,  and  that  when  his  bond 
matures  the  money  will  be  ready.  If  war  or  revo- 
lution destroys  his  investment,  if  fire,  flood,  earth- 
quake, or  tornado  falls  upon  the  property  which 
secures  his  bonds,  he  may  suffer  a  partial  or  total 
loss.  Short  of  such  calamities,  however,  which 
no  foresight  can  anticipate,  against  which  no 
forethought  can  provide,  the  conservative  invest- 
ment banker  can  assure  his  customers  absolute 
protection. 

He  can  give  them  this  assurance  because  he  has 
thoroughly  investigated  the  security  of  the  bonds 

84 


RELIABLE  INVESTMENT-BANKER 

which  he  sells.  He  has  satisfied  himself  that  all 
legal  safeguards  are  thrown  about  the  borrower, 
that  the  physical  condition  of  the  property  is 
sound,  that  the  total  bond-issue  is  less  than  the 
replacement  value  of  the  property,  that  the  earn- 
ings are  well  above  the  interest  charges,  that  the 
management  is  capable  and  progressive,  and  that 
the  demand  for  the  product  or  service — the  gas, 
or  water,  or  electricity,  or  transportation — which 
the  company  is  organized  to  furnish,  is  reasonably 
certain  to  increase.  By  the  banker's  investigation, 
every  unknown  factor  has  been  eliminated.  He  is 
offering  certainties  to  his  customers ;  he  sells  them 
a  secured  income  and  a  secured  return  of  principal. 
But  still  one  question  has  not  been  answered. 
What  is  the  backing  of  these  assurances?  What 
guaranty  does  the  banker  give  that  his  represen- 
tations and  his  promises  will  be  borne  out  by 
the  result?  If  you  purchase  a  house,  you  apply 
for  title  insurance.  For  a  small  fee,  a  trust 
company  places  its  surplus  and  capital  back  of 
your  title.  It  gives  you  absolute  assurance  that 
you  will  suffer  no  damage  from  any  defect  in 
your  title.  Does  the  investment-banker  give  the 
same  assurance? 

Suppose,  for  example,  that  you  buy  $5,000  bonds 
85 


THE  CAREFUL  INVESTOR 

secured  by  a  mortgage  on  a  trolley  system,  and 
that,  after  a  few  years,  your  interest  fails  to  be 
paid.  A  receiver  is  appointed  for  the  property. 
A  reorganization  plan  is  offered  the  bond-holders. 
What,  then,  will  be  the  attitude  of  the  banker 
who  sold  you  the  bonds?  Will  he  make  good  your 
loss,  or  will  he  cite  to  you  the  ancient  proverb, 
the  swindler's  city  of  refuge,  ''Caveat  Emptor" 
(Let  the  buyer  beware)  ?  Is  the  banker's  guaranty 
worth  anything?  Has  it  substance?  Granted  that 
it  is  only  a  moral  guaranty,  will  the  banker  make 
it  good? 

I  can  answer  this  question  by  citing  an  instance. 
About  twelve  years  ago,  a  newly  organized  banking- 
house,  anxious  for  business,  purchased,  after  what 
it  believed  to  be  sufficient  investigation,  an  issue 
of  bonds  secured  by  a  mortgage  on  a  city  street- 
railway.  They  had  employed  in  the  investigation 
a  well  known  accountant,  a  man  who  at  that  time 
enjoyed  a  national  reputation  because  of  sensa- 
tional disclosures  of  railway  mismanagement.  The 
accountant  did  not  conduct  the  investigation 
personally.  He  sent  his  son  in  his  stead,  but  he 
signed  the  report  of  earnings  and  expenses  on  the 
basis  of  which  the  banking-house  purchased  and 

sold  the  bonds. 

86 


RELIABLE  INVESTMENT-BANKER 

Shortly  afterward,  default  in  interest  occurred. 
The  bankers  were  astonished.  They  investigated. 
They  found  that  their  representative  had  been 
misled.  He  had  accepted  figures  of  earnings  which 
were  grossly  exaggerated.  The  management,  in 
order  to  make  the  necessary  showing  of  earnings, 
had  sold  large  quantities  of  tickets  at  wholesale 
rates,  which  the  company  had  to  redeem  in  trans- 
portation. These  ticket-sales  were  counted  as 
earnings.  Expert  accountant  fils  accepted  the 
figures,  which  included  these  advance  sales,  as 
accurate  representations  of  the  financial  condition 
of  the  company.  Expert  accountant  pere  signed 
his  son's  report.  The  bankers  had  been  grossly 
deceived  by  their  incompetent  representative. 
The  company  could  not  pay  its  interest.  Its  bonds 
were  in  default.  Many  of  these  bonds  had  been 
sold.    What  was  to  be  done? 

The  bankers  recognized  that  they  were  to  blame. 
The  investigation  had  been  faulty.  They  had 
failed  in  their  duty.  They  must  take  the  conse- 
quences. They  immediately  offered  to  repurchase 
all  bonds  of  this  issue  at  the  price  paid.  They 
actually  did  repurchase  more  than  $300,000  of 
them,  and  carried  them  for  seven  years  before  they 

were  able  to  recover  the  loss. 

87 


THE  CAREFUL  INVESTOR 

Their  case  illustrates  the  nature  as  well  as  the 
limitations  of  the  banker's  responsibility.  He  must 
not  misstate  the  facts  about  an  investment  to  his 
clients.  On  the  basis  of  these  facts,  he  recommends 
the  purchase  of  bonds  as  safe  investments.  If, 
however,  the  true  state  of  affairs  is  not  known  to 
the  banker;  if,  in  ignorance  of  facts,  a  knowledge 
of  which  would  make  him  refuse  the  purchase, 
he  buys  bonds  and  sells  these  to  his  customers, 
he  is  then  morally  bound  to  protect  his  customers 
against  loss.  A  reputable  banker  will  not  shirk 
this  obligation.  He  will  not  announce  in  his  cir- 
culars that  he  will  make  good  his  customers'  losses. 
He  will  not  authorize  his  salesmen  to  make  this 
statement.  He  will  not  formally  admit  his  re- 
sponsibility. But  when  the  loss  occurs,  if  it  is  his 
fault,  or  the  fault  of  his  agents  who  have  not 
placed  the  true  facts  of  the  proposition  before  him, 
he  will  protect  his  customers. 

Such  cases  are  rare.  I  knew  of  one  banking- 
house  which  had  been  in  business  for  thirteen  years, 
and  which  had  had  only  two  defaults  among  hun- 
dreds of  issues  which  it  has  placed  with  investors. 
In  only  one  case  was  the  house  responsible  because 
of  faulty  investigation.  In  both  cases  its  customers 
were  protected.     Another  house  has  had  three 


RELIABLE  INVESTMENT-BANKER 

defaults  in  the  same  number  of  years,  both  due  to 
technical  and  temporary  causes.  In  each  case  the 
customers  were  protected. 

Sometimes  the  banking-house  will  not  go  so  far 
as  to  buy  back  defaulted  bonds.  If  the  company 
is  sound,  and  the  embarrassment  certain  to  be 
temporary,  the  banker  must  take  another  course 
to  protect  his  customers.  A  prominent  banking- 
house  of  high  reputation  sold  a  large  issue  of  bonds 
secured  by  a  mortgage  on  the  property  of  a  public- 
service  corporation.  The  bonds  were  perfectly 
secured,  assuming  that  the  management  was 
honest.  The  stock-holding  control  of  this  com- 
pany, however,  thought  to  play  a  sharp  trick  on 
the  bond-holders.  They  diverted  earnings  from 
interest  into  improvements,  defaulted  on  the 
bonds,  and  secured  the  appointment  of  a  receiver, 
thinking  to  force  a  compromise  with  the  bond- 
holders. 

The  banking-house  which  had  placed  the  bonds 
immediately  took  charge.  They  laid  the  true 
state  of  affairs  before  the  bond-holders.  They 
assured  them  that  their  investment  was  perfectly 
safe.  They  invited  their  cooperation  in  wresting 
the  control  from  the  dishonest  management.  Most 
of  the  bond-holders  placed  their  interests  in  the 

89 


THE  CAREFUL  INVESTOR 

hands  of  the  banking-house  which  took  charge  of 
the  reorganization,  securing  for  the  bond-holders 
in  the  new  company  not  only  the  same  interest 
which  they  had  in  the  old  company,  but  securities 
representing  a  large  share  of  the  profits  in  addition. 
This  house  has  lost  nothing  of  its  high  reputation 
by  the  course  of  action  which  it  pursued  in  this 
matter, 

I  have  said  that  the  reputable  investment- 
banker  will  always  protect  his  clients.  Yet  how 
is  the  investor  to  distinguish  between  the  repu- 
table investment-bankers  and  those  who  look 
on  bonds  as  the  peddler  regarded  razors,  as  pri- 
marily made,  not  for  service,  but  for  sale.  We 
can  find  plenty  of  bankers  who  will  not  protect 
their  customers,  who  use  them  like  a  flock  of 
sheep,  shearing  them  from  time  to  time,  and  yet, 
by  some  strange  credulity  which  infests  the  minds 
of  a  certain  type  of  investors,  keeping  their  hold 
upon  them. 

I  am  familiar  with  the  history  of  one  of  these 
firms.  Strangely  enough,  its  reputation  is  high 
in  its  city  and  State.  Its  members  are  counted 
among  the  prominent  financiers  of  their  commun- 
ity.   Its  list  of  clients  is  long  and  loyal.    This  firm 

has  sold  a  number  of  issues  of  bonds  whose  security 

90 


RELIABLE  INVESTMENT-BANKER 

was  bad  and  which  have  been  in  default.  The 
head  of  the  firm  is  quite  frank  about  the  matter. 
He  once  said  that  his  customers  did  not  mind 
bankruptcy.  They  were  willing  to  go  through 
reorganization.  Some  day  they  would  make  some 
money.  A  member  of  this  firm  expressed  mild 
surprise  at  the  painstaking  investigation  which 
another  house  thought  it  necessary  to  make  before 
buying  some  bonds.  He  was  asked  how  his  house 
proceeded.  "Well,"  he  replied,  "I  guess  we  buy 
bonds  by  instinct."  The  record  of  his  firm  bears 
out  his  statement. 

There  is  only  one  sure  test  of  the  character  of  a 
banking-house — its  record  of  flotations.  If  we 
could  have  for  every  investment-banker  who  offers 
his  wares  to  the  public,  a  list  of  the  bonds  and 
stocks  which  he  has  offered  for  sale,  the  represen- 
tations made  at  the  time  of  issue,  and  the  subse- 
quent history  of  these  securities,  we  should  have 
a  nearly  infallible  guide  to  his  trustworthiness. 
Such  a  compilation  could  be  easily  made.  It 
would,  however,  furnish  a  series  of  comparative 
revelations  as  to  the  records  of  various  banking- 
houses,  which  would  not  only  be  illuminating  but 
amazing.  On  the  basis  of  such  a  record,  the  inves- 
tor could  place  his  money  in  full  confidence  that 

91 


THE  CAREFUL  INVESTOR 

the  houses  from  whom  he  purchased  were  worthy 
of  his  trust.  I  suggest  to  every  investor  that, 
before  buying  any  securities,  he  investigate  the 
record  of  the  house  which  offers  them.  In  most 
cases  he  will  find  that  record  both  fair  and  honor- 
able. Such  an  investigation,  however,  may  save 
him  from  loss. 


VII 

PUBLIC  OBLIGATIONS— MUNICIPAL 
BONDS  PREFERRED 

For  the  conservative  investor  who  looks  for 
absolute  safety  of  principal,  and  who  is  willing 
to  make  some  sacrifices  of  income  in  order  to  secure 
absolute  safety,  the  municipal  bond  has  the  first 
choice.  United  States  Government  bonds,  it  is 
true,  are  safer,  but  the  demands  for  these  bonds 
from  national  banks,  who  use  them  as  a  basis  for 
circulating  notes,  and  to  secure  deposits  of  money 
with  them  by  the  government,  is  so  great  that 
they  yield  Httle  more  than  2  per  cent.  This  yield 
is  too  small  to  be  attractive  even  to  the  most  con- 
servative investor.  Of  the  government  bonds  out- 
standing amounting  to  $963,349,390,  $193,526,090 
are  held  by  national  banks. 

State  bonds  are  distinctly  inferior  to  municipal 
bonds.  In  the  eleventh  amendment  to  the  Con- 
stitution of  the  United  States  it  is  provided  that 
"the  judicial  power  of  the  United  States  shall  not 
be  construed  to  extend  to  any  suit  in  law  or  equity 
commenced   or   prosecuted    against    any    of    the 

93 


THE  CAREFUL  INVESTOR 

United  States  by  citizens  of  another  State,  or  by 
citizens  or  subjects  of  any  foreign  state."  Under 
this  amendment,  any  State  may  repudiate  its  obli- 
gations, and  a  number  of  States  have  done  so,  at 
different  times,  and  for  a  variety  of  reasons.  Fol- 
lowing the  panic  of  1837,  during  a  period  of  severe 
industrial  depression,  Pennsylvania,  Maryland, 
Indiana,  Illinois,  Michigan,  Florida,  and  Missis- 
sippi repudiated  their  debts,  declared,  in  effect, 
that  they  were  unable  to  pay  their  creditors.  Of 
the  four  Northern  States,  Michigan  was  the  only 
one  which  did  not  eventually  pay  in  full.  In  the 
South,  Florida  and  Mississippi  were  guilty  of 
deliberate  repudiation.  Minnesota,  in  i860,  re- 
pudiated certain  bonds  issued  in  aid  of  railroad 
construction.  These  bonds  were  eventually  re- 
deemed at  fifty  cents  on  the  dollar,  with  accrued 
interest.  Following  the  Civil  War,  came  a  wave 
of  repudiation  in  the  South.  From  1870  to  1884, 
nine  Southern  States  defrauded  their  creditors  by 
stopping  payment  on  the  bonds.  A  large  part  of 
this  debt  w^as  due  to  the  extravagance  and  rascality 
of  the  "carpet-bag"  period,  and  these  abuses  were 
urged  in  defense  and  extenuation  of  the  wholesale 
repudiation  of  written  obligations.    Whatever  the 

cause,  by  1870  the  bonds  of  the  Southern  States 

94 


PUBLIC  OBLIGATIONS 

in  default  had  reached  $170,025,340,  an  increase 
of  $82,257,650  over  the  amount  of  defaulted  debt 
in  i860. 

There  is  a  kindly  and  classical  explanation  of 
the  tendency  of  the  Southern  States  to  repudiate, 
which  applies,  however,  mainly  to  antebellum  de- 
faults. Mr.  Justice  Curtice,  in  an  article  in  the 
North  American  Review  for  January,  1844,  referring 
to  a  repudiation  of  debt  by  the  State  of  Mississippi, 
says: 

To  pay  debts  punctually  is  the  point  of  honor  among  commer- 
cial peoples.  But  the  planters  of  Mississippi  do  not  so  esteem  it. 
They  do  not  feel  the  importance  of  an  exact  conformity  to  con- 
tracts. It  has  not  been  their  habit  to  meet  the  engagements  on 
the  very  day,  if  not  quite  convenient.  Certainly  they  attach  no 
idea  of  dishonesty  to  such  a  course  of  dealing.  They  mean  to 
pay,  but  they  did  not  expect  when  they  contracted  the  debt  to 
distress  themselves  about  the  payment.  If  a  friend  wants  a 
thousand  dollars  for  a  loan  or  a  gift,  he  can  have  it,  though  per- 
haps a  creditor  wants  it  also.  We  do  not  mean  to  intimate  that 
there  are  no  high  qualities  in  such  a  character,  but  they  are 
different  from  those  which  make  good  bankers  or  merchants,  and, 
therefore,  bankers  and  merchants  ought  not  to  expect  such  men 
to  look  at  a  debt  just  as  they  do. 

To  explain  the  repudiation  of  the  carpet-bag 
debts,  we  can  resort  to  an  illustration  in  another 
field.  One  of  the  favorite  methods  of  swindling 
the  farmer  twenty  years  ago  was  by  securing  his 
signature  to  a  document,  one-half  of  which  was  a 

95 


THE  CAREFUL  INVESTOR 

receipt,  or  bill  of  sale,  or  some  such  innocent  thing, 
and  the  other  half,  which  was  folded  under  so  as 
to  be  concealed  from  the  victim's  gaze,  was  a 
promise  to  pay.  The  innocuous  part  of  the  docu- 
ment would  subsequently  be  cut  off,  and  the 
promissory  note,  signed  in  ignorance  of  its  real 
nature,  and  by  the  victim  of  a  gross  and  palpable 
fraud,  would  be  discounted  at  a  bank.  In  time, 
this  note  would  be  presented  for  payment  by  the 
bank,  an  innocent  holder  for  value,  and  entitled 
to  collect  on  the  fraudulent  note. 

In  order  to  comprehend  the  attitude  of  the 
people  of  North  CaroHna  or  Mississippi  toward 
their  bonds  issued  during  the  reconstruction  period 
we  have  only  to  picture  the  attitude  of  mind  of 
the  aforesaid  farmer,  supposing  there  was  no  law 
protecting  the  innocent  holder  for  value  of  a 
negotiable  instrument,  when  the  bank  which  had 
purchased  one  of  these  fraudulent,  though  in  form 
genuine,  notes,  asked  for  payment.  Would  he 
pay  such  a  note?  We  think  he  would  not.  He 
would  not  even  extend  to  the  banker  his  sympathy. 
He  would  laugh  in  derision  at  the  banker's  calamity. 

Now,  this  is  exactly  the  attitude  of  the  Southern 

States.     There  is  no  law  which  compels  them  to 

pay  their  debts.    The  construction  of  the  United 

96 


PUBLIC  OBLIGATIONS 

States  makes  them  immune  from  prosecution.  No 
one  can  touch  them.  These  debts,  they  claim,  are 
tainted  with  fraud.  They  will  not  pay  them,  and 
look  the  whole  world  in  the  face  when  they  say  it. 

There  will  come  a  time  when  these  debts  will 
be  paid.  These  Southern  States  will  need  money 
for  public  improvements.  In  order  to  sell  new 
bonds,  they  must  first  settle  with  existing  creditors. 
This  will  not  be  a  matter  of  sentiment  or  honor, 
but  of  business.  When  that  time  comes  State 
bonds  will  improve  their  standing.  At  present, 
however,  although  some  States,  such  as  New  York, 
enjoy  excellent  credit,  the  reputation  of  State 
bonds  as  a  class  is  somewhat  frowned  upon. 

Municipal  bonds  stand  upon  a  different  footing. 
Instead  of  the  optional  honesty  of  the  State,  an 
honesty  depending  on  the  prevalence  and  pre- 
dominance of  the  commercial  spirit  among  her 
citizens,  and  upon  the  necessity  of  appealing  from 
time  to  time  for  new  loans  to  the  creditors,  we 
find  in  the  municipal  bond  the  guaranty  of  a 
secured  obligation.  Even  in  those  States  which 
have  repudiated  their  written  obligations,  these 
smaller  political  units,  the  municipalities,  enjoy 
excellent  credit.    Their  bonds  are  in  good  demand, 

because  both  principal  and  interest  are  secured. 
7  97 


THE  CAREFUL  INVESTOR 

The  explanation  of  this  difference  is  found  in  the 
fact  that  these  smaller  governmental  bodies  do 
not  enjoy  the  same  immunity  as  the  State.  They 
can  be  sued  by  the  creditor. 

We  hear  much  about  the  good  faith  of  the 
public.  We  are  told  that  it  represents  the  distilled 
essence  of  a  multitude  of  private  consciences,  that 
it  is  a  higher,  nobler,  more  dependable  thing  than 
the  good  faith  of  the  individual.  This  view  of 
public  honor  is  not  entirely  correct.  Edmund 
Burke,  in  his  "Reflections  on  the  Revolution  in 
France,"  speaks  of  a  perfect  democracy  as  "the 
most  shameless  thing  in  the  world."    As  he  says: 

The  share  of  infamy  that  is  likely  to  fall  to  the  lot  of  each 
individual  in  public  acts  is  small  indeed,  the  operation  of  opinion 
being  in  the  inverse  ratio  to  the  number  of  those  who  abuse 
power.  Their  own  approbation  of  their  own  acts  has  to  them  the 
appearance  of  a  public  judgment  in  their  favor. 

And  in  another  place : 

Society  requires  not  only  that  the  passions  of  individuals 
should  be  subjected,  but  that  even  in  the  mass  and  body,  as  well 
as  in  the  individual,  the  inclinations  of  men  should  frequently  be 
thwarted,  their  will  controlled,  and  their  passions  brought  into 
subjection.  This  can  only  be  done  by  a  power  out  of  themselves, 
and  not,  in  the  exercise  of  its  function,  subject  to  that  will  and 
to  these  passions  which  it  is  its  office  to  bridle  and  subdue. 

The  State  may  be  taken  as  the  perfect  de- 
mocracy to  which  Burke  refers.    Some  American 

98 


PUBLIC  OBLIGATIONS 

Slates  are  shameless,  though  populous  with  men 
honorable  in  all  private  business  relations.  The 
towns  and  cities  of  these  States,  however,  are  cor- 
porations, chartered  by  the  State  for  the  perform- 
ance of  the  local  functions  of  government,  author- 
ized to  borrow  money,  and  compelled  by  the  law 
to  repay  what  they  have  borrowed,  by  a  "power 
outside  of  themselves." 

The  security  of  a  municipal  bond  is  twofold: 
first,  the  property  not  used  for  the  purpose  of 
government  which  the  city  may  own,  and  which 
can  be  sold  under  execution  in  satisfaction  of  a 
judgment;  and,  second,  the  obligation  of  the 
municipal  officers,  when  ordered  to  do  so  by  the 
court,  to  levy  taxes  for  the  payment  of  principal 
and  interest  of  their  debts. 

Some  States  provide  in  their  constitutions  that 
when  a  debt  is  incurred,  provision  must  be  made 
by  taxation  to  repay  the  debt  at  maturity,  and, 
in  the  meantime,  to  pay  the  interest.  It  is  a  gen- 
eral rule  also,  even  when  the  constitution  does 
not  provide  for  such  a  tax,  and  also  to  supplement 
the  constitutional  requirement,  that  the  local 
authorities  should,  by  municipal  ordinance,  pro- 
vide for  the  tax.  Even  without  special  provisions 
in  State  constitution  or  local  ordinance,  the  gen- 

99 


THE  CAREFUL  INVESTOR 

eral  power  of  taxation  can  be  invoked  by  the 
creditor  in  case  of  default,  and  court  orders  can 
compel  public  officers  to  levy  the  tax. 

Municipal  bonds  differ  from  the  bonds  of  pri- 
vate corporations  in  that  they  must  be  issued  in 
strict  compliance  with  the  law.  The  history  of 
municipal  borrowing  in  the  United  States  abounds 
with  instances  of  folly.  Bonds  have  been  issued 
in  aid  of  public  improvements  which  never  ma- 
terialized. Bonds  have  been  sold  to  enormous 
amounts  whose  proceeds  never  found  their  way 
into  the  public  treasury.  Every  financial  wrong 
inflicted  on  the  Southern  people  by  the  recon- 
struction governments  can  find  its  counterpart 
in  the  borrowing  by  Northern  municipalities. 
Learning  wisdom  by  experience,  the  people  have, 
in  their  State  constitutions,  and  in  the  statutes 
under  which  municipal  corporations  are  char- 
tered, imposed  upon  those  bodies  a  variety  of 
restrictions.  These  restrictions,  since  they  enforce 
caution  and  conservatism  upon  the  municipal 
authorities,  contribute  also  to  the  security  of  the 
investor. 

In  the  first  place,  municipalities  are  generally 
prohibited  from  incurring  debt  in  aid  of  any  rail- 
road or  other  outside  enterprise.    The  proceeds  of 

100 


PUBLIC  OBLIGATIONS   "  •     " 

municipal  bond  sales  must  be  spent  in  and  for  the 
benefit  of  the  borrowing  community. 

The  amount  of  the  debt  is  closely  limited.  The 
standard  of  limitation  is  the  assessed  value  of 
the  property  in  the  town  or  city.  With  few  ex- 
ceptions, the  assessed  value  is  far  below,  usually 
Httle  more  than  half,  the  market  value.  On  the 
basis  of  this  assessed  value,  cities  are  prohibited 
from  incurring  more  than  small  percentages, 
ranging  from  i>^  to  15  per  cent,  of  debt.  A  Hmit 
of  five  per  cent,  on  the  assessed  valuation,  a  com- 
mon restriction,  with  an  assessment  of  50  per  cent, 
of  selling  value,  is  equivalent  to  a  stipulation  that 
the  city  must  not  borrow  more  than  2>^  per  cent, 
of  the  amount  at  which  its  taxable  property  should 
be  valued. 

The  State  also  takes  great  care  that  loans 
should  be  incurred  only  after  full  deliberation  by 
the  municipal  authorities;  in  many  States,  after 
the  voters  have  had  an  opportunity  to  pass  upon 
the  wisdom  of  the  loan.  The  utmost  care  is  taken 
to  secure  complete  pubHcity.  In  order  that  the 
highest  price  shall  be  obtained,  competitive  bids 
are  invited,  accompanied  by  certified  checks  for 
substantial  amounts  as  evidence  of  good  faith.  In 
every  possible  way,  the  State  protects  the  pubHc, 

101 


THE  CAREFUL  INVESTOR 

and,  in  so  doing,  protects  the  investor  against 
excessive  bond  issues,  for  purposes  of  which  the 
people  do  not  approve,  or  for  which  the  issuing 
municipalities  do  not  receive  full  value. 

These  legal  restrictions  on  municipal  borrowing 
while  they  protect  the  investor  when  observed, 
also  make  it  necessary  for  him  to  be  on  his  guard 
to  see  that  they  have  been  fully  complied  with. 
When  a  railroad  company  issues  bonds,  every 
provision  of  its  charter  and  by-laws  may  have 
been  violated  by  the  making  of  the  loan,  and  yet 
the  innocent  holder  of  these  bonds  will  be  pro- 
tected. He  is  not  supposed  to  have  knowledge  of 
or  to  be  held  responsible  for  the  internal  arrange- 
ments of  the  company  to  which  he  loans  money. 
He  has  done  his  part  by  giving  value  for  the 
bonds.  If  the  company  has  been  defrauded  of  a 
part  of  the  proceeds  of  these  bonds,  or  if  they  have 
been  issued  for  a  purpose  which  the  charter  for- 
bids, the  company  should  look  for  compensation 
and  reimbursement  to  those  officials  who  are 
responsible. 

With  a  municipal  bond,  the  case  is  different. 
The  regulations  which  govern  their  issue  are  a 
part  of  the  laws  of  their  State.  Every  one  is  sup- 
posed to  have  knowledge  of  them.     The  bond- 

102 


PUBLIC  OBLIGATIONS 

buyer  must  have  these  regulations  in  mind.  He 
must  assume  that  they  have  been  complied  with. 
If,  in  any  substantial  respect,  these  regulations 
have  not  been  closely  followed,  the  bonds  may  be 
held  invalid.  A  little  book  entitled  "Municipal 
Bonds  Held  Void,"  by  Maurice  B.  Dean,  of  the 
New  York  Bar,  gives  a  complete  list  of  those 
obligations  in  the  purchase  of  which  the  creditor 
lost.    From  this  digest  I  take  the  following: 

In  1904,  $4,000  of  bonds  issued  by  the  village 
of  Grant,  Nebraska,  were  held  invalid  "because 
they  were  issued  in  aid  of  private  water- works," 
an  unlawful  purpose.  As  authority  for  their 
issue,  the  bonds  referred  to  a  statute  which  did 
not  convey  authority.  The  court  said:  "The 
bonds,  therefore,  bear  upon  their  face  ample  evi- 
dence of  their  own  invalidity,  and  no  one  can 
claim  to  be  a  bona  fide  purchaser  of  a  bond  which 
carried  on  its  face  evidence  of  its  unlawful  char- 
acter." 

A  Michigan  case  is  even  more  significant.  The 
village  of  Ashley  sold  $8,500  of  water- works  bonds 
under  a  resolution  of  the  village  council,  which, 
while  it  authorized  the  president  and  clerk  to  sign 
water- works  bonds,  did  not  authorize  the  president 
to  deliver  the  bonds.     The  bonds,  having  been 

103 


THE  CAREFUL  INVESTOR 

delivered  without  authority,  were  held  to  be  void, 
although  in  the  hands  of  a  bona  fide  holder." 

An  Indiana  case  shows  how  far  the  taint  of  ille- 
gality can  persist.  The  city  of  Jeffersonville  had 
issued  and  sold  bonds  to  obtain  money  to  contest 
litigation  changing  the  county  seat.  At  a  later 
time  it  desired  to  take  up  these  bonds  with  a  new 
issue.  The  issue  was  enjoined  by  a  tax-pa3^er, 
and  the  original  issue  was  held  to  be  void  because 
made  for  an  illegal  purpose." 

Out  of  this  situation  arises  the  need  of  a  careful 
legal  investigation  before  municipal  bonds  can  be 
safely  offered  to  the  investor.  The  buyer  of  a 
municipal  bond  cannot  be  an  innocent  holder  for 
value.  Ignorance  of  the  law  cannot  be  urged  in 
his  favor.  He  is  charged  with  constructive  knowl- 
edge of  any  illegality  in  the  procedure  under  which 
his  bonds  were  issued.  If  every  requirement  laid 
down  in  the  law  to  govern  the  issue  of  the  bonds 
has  not  been  complied  with,  his  bonds  are  invalid. 

This  does  not  mean  that  the  bond-holder  will 

necessarily  lose.     He  can  still  fall  back  on  the 

good  faith  of  the  people,  estimating  this  at  its 

problematical  value.    But  the  trouble  is  that  after 

bonds  have  been  tainted  with  illegality,  there  is 

no  legal  way  in  which  they  can  be  paid,  except 

104 


PUBLIC  OBLIGATIONS 

by  popular  subscription,  until  the  law  is  changed. 
The  city  of  Helena,  Montana,  through  no  fault  of 
its  own,  is  unable  to  pay  certain  bonds  which, 
owing  to  a  decline  in  the  value  of  the  city's  prop- 
erty, are  issued  to  an  illegal  amount.  The  city 
stands  ready  to  pay  these  bonds  whenever  a  legal 
method  can  be  found.  Meanwhile  the  holders 
suffer  loss. 

The  bond-house  purchasing  an  issue  of  munici- 
pals, therefore,  centres  its  inquiry  upon  the  legality 
of  the  issue.  It  takes  into  account  other  factors — 
the  productiveness  of  the  assets,  such  as  water- 
works, which  are  to  be  constructed  with  the  pro- 
ceeds of  the  bonds ;  the  population  of  the  borrow- 
ing community,  its  record  of  good  faith  toward 
its  creditors,  the  assessed  value  of  the  property, 
and  any  other  factors  which  may  bear  upon  the 
merits  of  the  flotation  as  a  business  proposition. 

The  chief  concern  of  the  banking  house  is  with 
the  legality  of  the  municipal  bond  issue.  Munici- 
pal, school  district,  and  county  bonds  are  good, 
if  they  are  legal.  The  margin  of  a  security  in  the 
value  of  a  town's  property  over  the  total  amount 
which  it  is  allowed  to  borrow  is  so  great  as  to 
eliminate  the  element  of  business  risk  which  the 

purchaser  of  railroad  bonds,  for  example,  must 

105 


THE  CAREFUL  INVESTOR 

consider.  The  bond-house,  for  this  investigation, 
relies  upon  the  advice  of  the  best  lawyers  it  can 
secure.  In  some  cases  the  opinions  of  two  firms 
are  taken. 

The  lawyer's  statement  to  the  bond-house 
answers  the  following  questions : 

(i)  Is  the  city  permitted  by  its  charter  and  by  the  State  con- 
stitution and  Acts  of  Assembly  to  issue  bonds  for  the  purposes 
proposed? 

(2)  Have  the  necessary  formaHties,  such  as  passage  of  ordi- 
nances, approval  by  the  mayor,  etc.,  been  taken  by  the  city? 

(3)  If  necessary,  has  the  bond  issue  been  approved  at  an  elec- 
tion, and  in  that  case,  has  the  election  been  conducted  according 
to  the  prescribed  form? 

(4)  Have  the  legal  stipulations  concerning  advertisement, 
secrecy  of  bids,  and  award  to  the  highest  bidder  been  complied 
with? 

(5)  Is  the  amount  of  the  issue  within  the  limits  set  by  the 
statute? 

(6)  Is  the  form  of  the  bond  such  that  the  city  cannot  escape 
responsibility  by  any  technicality  or  slip  in  drawing  up  or  word- 
ing the  instrument? 

(7)  Have  the  present  bonds,  or  the  bonds  which  it  is  proposed 
to  refund  with  this  issue,  ever  been  subject  to  litigation? 

On  the  basis  of  these  legal  opinions,  for  which 
the  bond-house  must  sometimes  pay  large  fees, 
the  bonds  are  offered  to  the  investor,  who  may 
purchase  them  with  absolute  confidence  in  their 
validity.  Mr.  Lawrence  Chamberlain,  in  his  excel- 
lent work  "The  Principles  of  Bond  Investment," 

106 


PUBLIC  OBLIGATIONS 

states  that  in  1907,  out  of  $200,000,000  of  muni- 
cipal and  State  bonds  issued,  some  $4,000,000,  of 
2  per  cent.,  divided  among  65  municipal  issues, 
were  finally  declined  by  those  who  had  bought 
them  subject  to  the  approval  of  their  attorneys, 
usually  on  the  ground  of  their  illegality. 

To  show  the  care  exercised  in  this  matter,  I 
recall  an  instance  where  a  New  York  house  refused 
to  purchase  an  issue  of  school-district  bonds,  be- 
cause, while  the  law  required  that  the  notice  of 
the  election  to  authorize  the  bonds  should  be 
posted  for  a  certain  time  on  the  front  door  of  the 
school-house,  it  appeared  that  the  notice  had  been 
posted  on  the  side  door. 

In  some  States — New  Jersey,  North  Dakota, 
Texas,  Georgia  and  Kansas — the  law  now  pro- 
vides for  a  "State  certificate  of  validity"  usually 
endorsed  on  the  bond  by  some  State  official.  When 
this  safeguard  is  provided,  a  legal  investigation  is 
not  absolutely  necessary,  although  it  will  usually 
be  made  as  an  extra  precaution.  Elsewhere,  how- 
ever, the  investigation  by  the  attorneys  is  indis- 
pensable to  security. 


VIII 

HIGH- YIELD  MUNICIPAL  BONDS 

It  is  not  going  too  far  to  say  that  the  bonds  of 
American  cities  rank  among  the  safest  investments 
in  the  world.  We  find,  however,  that  outside  of 
institutions,  especially  savings-banks  and  the  more 
conservative  class  of  investors,  municipal  bonds 
are  not  popular.  The  reason  is  that  in  the  section 
of  the  country  where  most  of  the  funds  available 
for  investment  are  concentrated — the  Northern 
States — the  bonds  of  municipalities  sell  at  much 
higher  figures,  thus  offering  little  inducement  to 
the  investor.  In  the  State  of  New  York,  for 
example,  we  find  the  prevailing  yield  on  municipal 
bonds  to  be  from  4  to  4.20  per  cent.  In  New 
Jersey  the  rate  sometimes  runs  higher,  although 
some  of  the  bonds  of  Newark,  at  the  last  quota- 
tion, yielded  no  more  than  3.95  per  cent,  to  the 
investor.  In  the  New  England  States,  the  yield 
on  municipal  bonds  is  very  small.  The  bonds  of 
Boston  yield  only  3.90  per  cent,  and  the  bonds  of 
Connecticut,  whose  quotations  are  available,  show 
from  4.05  to  4.10  per  cent.    When  we  pass  outside 

108 


HIGH-YIELD  MUNICIPAL  BONDS 

the  North-eastern  States  we  find  an  immediate, 
although  only  a  moderate,  advance  in  the  yield 
on  bonds.  Bonds  of  Michigan  range  from  a  mini- 
mum of  4.50  per  cent,  to  a  maximum  of  4.60  per 
cent. ;  the  municipal  bonds  of  South  Dakota  run 
from  4.30  to  4.65  per  cent.  In  Tennessee  the  range 
is  about  the  same.  In  Texas  some  good  municipal 
bonds  can  be  purchased  to  yield  5  per  cent. 

The  difference  between  the  yields  of  the  muni- 
cipal bonds  in  the  East,  and  in  the  West  and 
South,  is  due  to  the  concurrence  of  several  influ- 
ences. The  investment  funds  are  largely  concen- 
trated in  the  East.  There  is  a  prejudice  in  the 
minds  of  all  investors  in  favor  of  the  bonds  of 
their  own  localities.  This  prejudice  is  also  enacted 
into  law  in  the  restrictions  placed  upon  the  invest- 
ments of  savings-banks.  These  banks  are  the 
principal  buyers  of  municipal  bonds,  and  the  im- 
mense demands  of  these  institutions  are  concen- 
trated upon  a  limited  number  of  issues.  For 
example,  the  savings-bank  law  of  Massachusetts 
limits  the  investment  of  savings  funds  to  the  bonds 
or  notes  of  any  city  of  the  five  New  England 
States,  or  of  any  county,  town,  or  water  district, 
which  conforms  to  certain  restrictions  as  to  the 

relation    between    indebtedness    and    valuation. 

109 


THE  CAREFUL  INVESTOR 

Outside  of  New  England,  Massachusetts  savings- 
banks  can  buy  municipal  bonds  of  New  York, 
Ohio,  Pennsylvania,  Indiana,  Illinois,  Michigan, 
Wisconsin,  Minnesota,  Missouri,  Iowa,  and  the 
District  of  Columbia,  when  issued  by  a  city  of 
more  than  30,000  inhabitants,  and  where  the  net 
debt  does  not  exceed  5  per  cent,  of  the  assessed 
valuation. 

Similar  restrictions  are  found  in  aU  the  States, 
and  these  restrictions  have  the  effect  of  so  con- 
centrating the  demand  for  municipal  bonds  as  to 
make  a  marked  difference  in  their  price.  An  issue 
by  a  small  town  in  Massachusetts,  for  example, 
may  be  no  better,  nor  even  as  good,  as  the  bonds 
of  Oklahoma  City.  The  Oklahoma  City  bonds, 
however,  will  sell  on  a  4^^  per  cent,  basis,  while 
the  bonds  of  Pittsfield,  Massachusetts,  will  sell 
on  a  3^  per  cent,  basis.  There  is  no  question 
about  the  honesty  of  the  people  of  Oklahoma  City, 
or  of  the  value  of  their  property,  or  of  the  industrial 
future  of  their  city.  The  bonds  of  Oklahoma  City 
are  perfectly  good.  They  are  not,  however,  avail- 
able for  a  certain  restricted  class  of  investment, 
and  there  is  a  natural  prejudice  against  them  on 
the  part  of  Eastern  investors.    This  explains  their 

low  price  and  high  yield. 

110 


HIGH-YIELD  MUNICIPAL  BONDS 

There  is  another  class  of  municipal  bonds  issued 
by  tax  districts,  which,  when  issued  under  proper 
restrictions,  and  purchased  from  rehable  bond- 
houses,  give  the  investor  excellent  security  and 
high  return.  I  have  before  me  the  6  per  cent, 
bonds  of  a  certain  levee  district  in  one  of  the 
Southern  States.  The  valuation  of  taxable  prop- 
erty in  this  district  is  $1,250,000,  and  the  total 
debt  is  $160,000.  The  present  value  of  the  land 
in  the  district  is  from  $15  to  $40  per  acre.  The 
issuing  bond-houses  state  that  land  outside  the 
district,  which  is  not  subject  to  flooding,  sells 
from  $75  to  $100  per  acre.  The  total  area  of  the 
district  is  59,596  acres,  and  the  debt,  per  acre,  is 
only  $2.68,  or  less  than  20  per  cent,  of  the  value 
of  the  cheapest  land  in  the  district. 

Another  illustration  of  tax-district  bonds  comes 
from  Seattle  in  an  issue  of  $30,000  ten-year  6  per 
cent,  bonds,  issued  for  regrading  certain  streets 
adjacent  to  the  main  business  centre  of  Seattle. 
A  large  number  of  offerings  of  this  kind  are  avail- 
able to  the  investor. 

In  view  of  these  high  interest  rates,   usually 

ranging  from  5  to  6  per  cent,  or  higher,  and  also 

because  of  the  lack  of  familiarity  of  the  Eastern 

investor  with  such  issues,  it  is  important  to  under- 
ill 


THE  CAREFUL  INVESTOR 

stand  the  security  back  of  these  bonds.  All  tax 
districts,  such  as  school  districts,  levee  districts, 
irrigation  districts,  or  sewerage  districts,  are 
agencies  of  the  State  which  have  been  established 
to  serve  local  public  purposes.  These  districts 
sometimes  coincide  with  the  areas  of  municipali- 
ties, and  sometimes  include  parts  of  several  muni- 
cipaHties.  The  issuing  of  the  obligations  for  the 
financing  of  a  local  improvement  of  this  character 
is  usually  authorized  at  a  special  election.  At 
this  election,  a  stated  majority  of  the  voters  living 
in  a  certain  locaHty  which  is  to  be  benefited  by 
particular  improvements,  such,  for  instance,  as 
the  regrading  of  certain  streets  in  Seattle,  or  the 
construction  of  a  levee  in  Louisiana,  must  signify 
their  willingness  to  pay  special  taxes  which  are 
to  be  levied  on  the  property  benefited. 

The  improvement  will  increase  the  value  of  the 
property.  The  owners  of  the  property  are  willing 
to  pay  the  cost  of  the  improvement,  and  the  fund 
to  pay  the  cost  will  be  created  by  the  improvement 
which,  if  wisely  planned  and  properly  made, 
should  increase  the  value  of  the  property  far  more 
than  the  amount  of  the  incumbrance  placed  upon 
it  by  the  bond  issue.  These  special  tax-district 
bonds  are  considered  apart  from  the  municipal 

112 


HIGH-YIELD  MUNICIPAL  BONDS 

debts  of  the  town,  a  part  or  all  of  whose  area  may 
be  included  in  the  tax  district.  The  burden  is 
borne,  not  by  all  the  tax-payers,  but  by  a  partic- 
ular group  of  tax-payers. 

The  usual  remedy  provided  in  case  of  default 
on  special  assessment  bonds  is  the  same  as  that 
provided  for  the  collection  of  municipal  bonds 
proper.  For  example,  in  Kansas,  the  holder  of 
improvement  bonds,  for  which  the  law  provides 
special  assessments  against  adjacent  property,  is 
entitled  to  mandamus,  ordering  a  general  tax 
levy  to  pay  his  judgment,  and  the  city  can  then 
reimburse  itself  by  levying  assessments  upon  the 
property  affected. 

Special  assessment  bonds  are  sometimes  given 
special  security.  In  Illinois,  for  example,  bridge 
districts  issue  bonds  which  are  a  direct  lien  on  the 
property  of  the  district.  On  the  bond,  before  it 
can  be  negotiated,  the  owner  of  each  piece  of 
property  must  place  this  endorsement,  and  his 
agreement  that  the  property  shall  become  liable 
for  the  interest  and  principal  of  the  obligation, 
and  that  the  bonds  shall  be  a  lien  upon  the  prop- 
erty until  it  is  paid  off  and  discharged. 

The  issue  of  tax-district  bonds  is  a  method  of 
evading  the  law  which  limits  the  borrowing  power 
8  113 


THE  CAREFUL  INVESTOR 

of  municipalities.  It  is  equally  certain,  however, 
that  in  view  of  the  conservatism  of  American 
legislative  bodies  on  the  subject  of  municipal 
debts,  the  special  dispensations  given  to  dis- 
tricts who  borrow  money  for  public  improvements 
are  not  likely  to  be  abused.  In  nearly  all  cases, 
these  special  assessment  bonds  are  sold  to  obtain 
money  for  public  improvements  which  will  greatly 
increase  the  value  of  the  property  affected.  A 
final  argimient  in  their  favor  is  that  this  property 
is  specifically  liable  for  the  repayment  of  the  bonds. 
We  may  conclude,  therefore,  that  in  the  bonds 
of  tax  districts  there  is  offered  to  the  investor 
an  obligation  which  combines  the  advantages  of 
high  yield  and  good  security,  security  which  is, 
on  the  whole,  better  than  can  be  furnished  him  by 
most  private  corporations.  With  the  continued 
development  of  the  newer  sections  of  the  United 
States,  these  tax-district  bonds  will  come  upon 
the  market  in  increasing  volume.  A  study  of  the 
advantages  which  they  offer  will  repay  the  investor 
who  wishes  to  combine  security  and  high  return. 


IX 
THE    AMERICAN    RAILWAY    INDUSTRY 

Greatest  of  all  sources  of  investment  is  the 
American  Railway.  For  forty  years  the  transpor- 
tation companies  of  the  United  States  have  poured 
into  the  world's  investment-market  a  flood  of 
securities.  The  savings  of  Europe  and  America 
have  found  their  largest  single  outlet  in  railway 
stocks  and  bonds.  The  volume  of  railway  securi- 
ties now  outstanding  presents  a  vast  total.  Of 
railway  stocks  there  were  outstanding  at  the  close 
of  191 1,  $8,582,000,000;  of  railway  bonds,  $10,- 
091,000,000.  This  sum  is  more  than  twice  the 
national  debts  of  the  entire  civilized  world.  It  is 
the  largest  single  contribution  to  the  world's 
savings.  If  we  except  the  value  of  land,  it  exceeds, 
in  size  and  value,  all  other  forms  of  investment 
in  the  United  States  combined. 

Of  recent  years,  railway  investments  have  de- 
clined in  favor.  Other  bonds  and  stocks  have 
entered  the  competition.  Pubhc  hostility  has  been 
aroused  against  the  railways.  They  have  been 
subjected  to  severe  regulation,  denied  the  right 

115 


THE  CAREFUL  INVESTOR 

to  advance  their  rates,  in  many  cases  forced  to 
reduce  them.  Long  enjoying  a  monopoly  of  the 
investment  market,  railway  directors  have  hesi- 
tated to  meet  the  demand  for  high-interest  bonds. 
They  have  halted  and  hesitated,  postponing  the 
inevitable  surrender  to  the  demand  for  securities 
paying  more  than  four  per  cent. 

We  have  here  an  explanation  of  the  decreasing 
output  of  railway  securities  in  recent  years,  and 
this,  in  turn,  explains  the  slow  progress  of  railway 
construction  during  the  same  period.  Observe  the 
figures.  From  1880  to  1890  our  railway  mileage 
increased  from  93,262  to  166,703;  from  1890  to  1900, 
although  this  was  a  period  of  panic  and  depression, 
drought  and  scanty  harvests,  the  growth  in  mileage 
was  166,703  to  194,262.  From  1900  to  1910,  how- 
ever, a  period  of  enormous  growth  in  other  lines  of 
business,  the  railway  system  increased  48,845  miles. 
In  191 1  only  3,465  miles  were  constructed. 

This  small  growth  in  mileage  does  not  mean  that 
American  railroads  are  standing  still.  During  the 
last  decade  they  have  spent,  measured  by  the 
increase  in  their  liabilities,  $6,719,000,000  upon  the 
properties.  The  expenditure  has,  however,  been 
rather  devoted  to  improving  facilities  than  to  build- 
ing new  lines.    Immense  tunnels,  the  Pennsylvania 

116 


THE  AMERICAN  RAILWAY  INDUSTRY 

and  New  York  Central  in  New  York,  the  North- 
western in  Chicago ;  costly  projects  of  electrification, 
such  as  that  carried  through  by  the  New  Haven  and 
Hartford ;  replacement  of  wooden  by  steel  equip- 
ment, and  large  additions  to  equipment,  have  en- 
gaged the  capital  available  for  railroad  construction. 

In  five  years,  from  1903  to  1907,  14,424  loco- 
motives and  536,942  freight  and  passenger  cars 
were  put  into  service.  Each  year's  additions, 
moreover,  are  of  larger  locomotives,  and  cars  of 
greater  cost  and  capacity.  Vast  sums  have  also 
been  spent  on  the  purchase  of  costly  city  real 
estate  required  for  larger  terminal  yards.  Track 
elevation,  installation  of  block-signals,  reduction 
of  grades,  and  elimination  of  curves,  have  all 
taken  substantial  shares  of  railway  funds. 

The  American  railway  industry,  considering  its 
size,  and  thelarge  number  of  companies  operatingit, 
is  the  soundest  and  strongest  business  in  the  world. 
Observe,  first,  the  size  of  the  plant  and  personnel : 
mileage,  359,000;  cars,  2,408,589;  locomotives, 
65,310;  employees,  1,699,420.  Over  10,000,000 
Americans  draw  their  living  from  the  railroads. 

The  business  which  is  conducted  by  this  great 

organization  is  worthy  of  it.     In  191 2  American 

railroads  transported  1,817,562,049  tons  of  freight 

117 


THE  CAREFUL  INVESTOR 

and  1,019,658,605  passengers.  Expressed  on  a 
mileage  basis,  these  figures  are  even  more  striking. 
Over  every  mile  of  American  railroad  in  1910  were 
carried  1,071,086  tons  of  freight  and  138,169 
passengers.  This  immense  business  was  done, 
moreover,  at  a  very  moderate  cost  to  the  shipper 
and  passenger,  a  fact  proven  by  an  average  freight 
rate  of  .748  cents  per  ton  per  mile  and  a  passenger 
rate  of  2.22  cents  per  passenger  per  mile.  No 
other  industry,  moreover,  performs  its  service  or 
furnishes  its  goods  at  so  small  a  margin  of  profit. 
In  the  opinion  of  the  best  informed  railway  men, 
the  passenger  business  is  operated  without  profit; 
and  out  of  the  three-fourths  of  a  cent  received  for 
each  ton  carried  one  mile,  it  is  a  safe  estimate  that 
not  more  than  one-fourth  of  a  cent  represents  profit. 
In  spite  of  these  small  profits  on  each  unit  of 
business  handled,  the  railway  industry  is  highly 
profitable,  owing  to  the  great  volume  of  the  traffic. 
For  the  year  ending  December  31,  191 1,  the  total 
profits  of  246,655  miles  of  railroad  operated  were 
$1,085,951,595,  or,  deducting  taxes,  $972,237,934. 
The  railway  industry,  on  a  gross  business  of  about 
three  billion  dollars  ($2,848,468,965),  makes  a 
profit  of  nearly  one  billion  dollars.  A  business 
which  can  show  one  dollar  in  three  as  profit  over 

118 


THE  AMERICAN  RAILWAY  INDUSTRY 

the  cost  of  operation  is  properly  characterized  as 
the  most  profitable  business  in  the  United  States. 
Even  the  United  States  Steel  Corporation,  gen- 
erally recognized  as  the  most  profitable  of  the 
large  industrials,  now  that  the  Standard  Oil  and 
American  Tobacco  Companies  have  been  dissolved, 
in  its  best  year,  1907,  on  a  gross  business  of  $757, - 
014,767.68  showed  $177,201,561  of  profits. 

And  this  introduces  us  to  the  second  character- 
istic of  the  railway  industry  which  especially 
recommends  railway  securities  to  the  investor. 
Not  only  is  the  railway  business  profitable,  but 
its  prosperity  is  continuous,  and  its  profits  are, 
therefore,  subject  to  smaller  fluctuations.  In  1908, 
the  year  following  one  of  the  severest  panics  in 
our  history,  railway  profits  declined  only  6.2  per 
cent.,  and  in  1909  they  more  than  regained  the  loss. 
In  good  times  and  in  bad,  railway  profits  not  only 
hold  their  own,  but  tend  strongly  to  advance. 

The  reason  for  this  movement  of  profits  it  is 
important  to  imderstand.  Profits  of  a  business  de- 
pend primarily  upon  the  demand  for  its  products. 
If  that  demand  is  sporadic  and  intermittent,  the 
business  will  be,  as  Andrew  Carnegie  said  of  steel, 
either  "a  prince  or  a  pauper."  But  if  the  demand 

is  continuous,  fluctuating  within   narrow  limits, 

119 


THE  CAREFUL  INVESTOR 

always  tending  upward,  and  if  the  business  shows 
a  large  margin  over  cost  of  operation,  we  have, 
from  the  investor's  standpoint,  an  ideal  situation. 
Such  a  condition  prevails  in  the  railway  world. 

The  advantage  of  the  railway  industry  from  the 
standpoint  of  stabiHty  of  profits  is  well  illustrated 
by  a  comparison  of  the  gross  earnings  of  the 
Pennsylvania  Railroad  with  those  of  the  United 
States  Steel  Corporation.  The  one  is  the  largest 
railroad  system  of  the  United  vStates  and  one  of 
the  best  managed,  and  the  other  is  the  largest  and 
one  of  the  best  managed  and  best  organized  in- 
dustries. The  steel  corporation,  moreover,  manu- 
factures a  great  variety  of  products,  so  that  its 
demand  would  naturally  be  more  stable  than  those 
of  steel  manufacturing  companies  whose  profits 
are  more  narrowly  specialized.  It  has  also  been 
able  to  maintain,  for  long  periods,  stable  prices 
for  most  of  its  products,  and  its  supremacy  in  the 
steel  trade  since  its  organization  has  only  recently 
been  challenged.  Competition,  until  the  winter 
of  1909,  very  slightly  disturbed  it,  and  yet  the 
fluctuation  of  its  gross  earnings,  compared  with 
the  Pennsylvania  Railroad,  which  appears  in  the 
following  table,  where  the  figures  are  stated  in 
millions  of  dollars,  is  extreme.    The  figures  for  the 

120 


THE  AMERICAN  RAILWAY  INDUSTRY 

Pennsylvania  Railroad  are  as  follows,   stated  in 
millions  of  dollars : 


1902. 

1903. 


112 
122 


118 


1904 

1905 133 

1906 148 

1907 164 

1908 136 

and  for  the  United  States  Steel  Corporation  as 

follows : 

1902 500 

1903 536 

1904 444 

1905 585 

1906 696 

1907 757 

1908 482 

The  percentages  of  fluctuations  from  one  year 
to  another  in  the  two  companies  are  as  follows : 

Pennsylvania  U.  S.  Steel 

Railroad  Corporation. 

1902 1515  

1903 +8.93  +7-20 

1904 -328  -17.16 

1905 +12.71  +3176 

1906 +11.28  +18.97 

1907 +10.81  +8.76 

1908 -17.08  -36.33 

Broadly  speaking,  the  distinction  which  has 
been  indicated  between  railway  and  manufacturing 
industries  holds  good  wherever  it  is  applied.    The 

121 


THE  CAREFUL  INVESTOR 

demand  for  transportation  services  offered  by  some 
railways,  especially  those  which  depend  exclusively 
upon  iron  and  steel  or  kindred  industries,  is  more 
irregular  than  those  of  some  manufacturing  com- 
panies— for  example,  gas  or  electric  lighting  com- 
panies or  companies  supplying  certain  food  pro- 
ducts which  are  regarded  as  necessaries  of  life. 
But  as  between  the  two  classes  of  corporations, 
railroads  and  industrials,  the  railway  has  a  marked 
advantage  in  the  greater  stability  of  the  demand 
for  its  service. 

The  railway  industry  is  also  distinguished  by 
its  comparative  freedom  from  competition.  What 
manufacturing  industry  has  vainly  tried  to  accom- 
plish by  unlawful  combination,  the  railroads  have 
achieved  without  conscious  effort,  solely  by  virtue 
of  their  economic  position.  The  cost  of  duplicating 
their  plant  is  so  great  as  to  protect  them  in  the 
enjoyment  of  the  traffic  of  which  they  have  gained 
control. 

From  every  standpoint,  the  investor  is  correct 
in  the  marked  preference  which  he  has  always 
shown  in  favor  of  railway  securities.  We  turn 
next  to  consider  certain  weaknesses  in  the  rail- 
road's position  which  arise  out  of  its  position  as 

a  public  servant. 

122 


RAILWAY  LABOR  AND  RAILWAY 
INVESTMENT 

The  most  important  problem  before  the  Ameri- 
can people  is  the  problem  of  railway  development. 
America  is  still  an  undeveloped  country.  Three- 
fourths  of  the  United  States,  industrially  consid- 
ered, lies  north  of  the  Ohio  and  east  of  the  Missis- 
sippi River.  The  West  and  South  are  yet  in  the 
infancy  of  their  business  development. 

The  realization  of  the  immense  possibilities  of 
this  country  must  depend  upon  the  extension  and 
development  of  our  railroad  facilities.  It  has  been 
estimated  by  men  whose  opinions  carry  great 
weight,  that  at  least  one  billion  dollars  each  year 
for  many  years  to  come  should  be  spent  in  rail- 
road building  and  rebuilding.  Some  of  this  new 
construction  will  be  immediately  profitable.  On 
the  largest  part,  the  profits  will  be  deferred.  That 
vast  expenditure  which  is  demanded  by  considera- 
tion of  public  safety  and  convenience  may  never  be 
profitable. 

In  recent  years,  railway  construction  has  lagged 

123 


THE  CAREFUL  INVESTOR 

behind  the  progress  of  other  industries.  A  present 
indication  of  this  fact  is  the  impending  shortage 
of  railway  equipment.  A  business  revival  has 
just  begun,  and  already  the  inadequacy  of  the 
transportation  system  to  carry  the  expected  in- 
crease in  traffic  is  conceded. 

The  railroads  are  unprepared,  not  because  they 
have  not  foreseen  the  return  of  good  times,  but 
because  of  certain  factors  in  the  situation  which 
make  directors  hesitate  to  invest  great  sums  of 
money,  even  when  the  condition  of  their  credit 
permits  great  sums  of  money  to  be  raised. 

This  feeling  of  doubt  and  distrust  of  the  future, 
which  is  ever^^where  encountered  among  railway 
officials  and  financiers,  is  due,  first,  to  the  apparent 
determination  of  the  Interstate  Commerce  Com- 
mission not  to  allow  any  general  advance  in  rates, 
and,  second,  to  the  increasing  pressure  of  the 
Railway  Brotherhoods  for  higher  wages. 

If  railway  expenses  are  not  increased,  the  present 
scale  of  rates  will  yield  satisfactory  profits.  But, 
from  the  attitude  of  railway  labor,  railway  ex- 
penses will  increase.  The  announced  determina- 
tion of  the  railway  labor  organizations  to  increase 
the  wages  of  their  members  is,  from  the  stand- 
point of  the  railway  and  of  the  country,  of  far 

124 


RAILWAY  LABOR  AND  INVESTMENT 

more  serious  import  than  the  unyielding  attitude 
of  the  Commerce  Commission. 

It  is  a  trite  saying  but  a  true  one,  that  transpor- 
tation is  the  Hfe-blood  of  commerce.  The  special- 
ization of  different  regions  to  those  industries  in 
which,  from  the  character  of  the  population,  their 
natural  resources,  or  their  proximity  to  markets, 
they  have  peculiar  advantages  has  been  carried 
so  far  in  this  country  that  free  and  continuous 
interchange  of  commodities  is  indispensable,  not 
only  to  industry,  but  to  existence.  Suspend  the 
operation  of  the  railroads  of  the  United  States  for 
one  week,  and  the  resulting  damage  would  be 
almost  incalculable.  It  would  be  measured  not 
in  money  and  in  goods  alone,  but  in  human  suffer- 
ing and  human  life.  How  many  cities  in  this 
country  are  provisioned  for  one  week?  How  long 
would  the  supply  of  fuel  and  material  for  the  mills 
and  factories  suffice,  if  fresh  supplies  were  inter- 
rupted? The  answers  to  these  questions  are  fur- 
nished by  every  snow-storm  which  ties  up  the 
railroads  of  a  section  even  for  a  few  days.  Every 
business  in  the  region  feels  the  effect.  The  whole 
population  suffers  inconvenience,  and  the  business 
losses  are  heavy. 

How  much  more  serious  would  be  the  effect  of 
125 


THE  CAFLEFUL  INVESTOR 

a  general  and  a  protracted  suspension  of  railroad 
transportation.  It  would  be  a  national  calamity 
comparable  to  the  effects  of  war  or  pestilence,  a 
catastrophe  which  it  is  almost  unthinkable  that 
any  body  of  men,  for  their  own  ends,  however 
worthy  and  reasonable  those  ends  might  be,  would 
combine  to  bring  upon  the  country ;  or,  to  look  at 
the  matter  from  another  standpoint,  it  is  even 
more  unthinkable  that  the  responsible  heads  of 
the  railway  companies  would  allow  a  general  sus- 
pension of  railway  operation  to  take  place  if  the 
most  extreme  concession  on  their  part  could 
prevent. 

Into  this  situation  of  absolute  dependence  upon 
the  continuous  operation  of  the  railroads,  a  situa- 
tion fraught  with  the  possibilities  of  national 
disaster,  enter  the  Brotherhoods  with  their  peri- 
odical demands  for  increases  in  wages,  reduction 
in  hours,  and  more  favorable  conditions  of  employ- 
ment. 

One  set  of  these  demands  made  by  the  Brother- 
hood of  Trainmen  is  now  being  considered  by  the 
Trunk  Lines.  The  Firemen  and  Engineers  have 
recently  gained  important  concessions  from  arbi- 
tration boards.  As  soon  as  this  difficulty  is  settled, 
and  from  past  experience  a  portion  at  least  of  the 

126 


RAILWAY  LABOR  AND  INVESTMENT 

demands  of  the  union  will  be  granted,  the  never- 
ending  controversy  will  be  transferred  to  some 
other  section  or  some  other  organization.  The 
pressure  of  the  unions  upon  the  railroads  is 
increasing  and  unceasing. 

In  these  discussions  and  contests,  organized 
railway  labor  possesses  a  predominant  advantage. 
They  know  just  how  valuable  their  services  are. 
They  know  that  the  trains  must  run,  and  that  no 
men  outside  their  organizations  can  run  them. 
Consider  for  a  moment  the  extent  of  their  advan- 
tage by  comparison  with  labor  contests  in  other 
fields.  If  the  anthracite  miners  strike,  the  country 
suffers,  but  there  are  ways  of  escape  for  the  con- 
stimer.  We  can  turn  to  bituminous  coal  or  gas, 
and  there  are  reserves  of  anthracite  to  draw  upon. 
If  the  bituminous  miners  strike,  the  users  of 
bituminous  coal  can  live  for  a  time  on  their  own 
reserves,  or  they  can  change  their  grates  to  bum 
anthracite.  The  last  great  strike  in  the  iron  and 
steel  industry  had  little  more  than  a  local  signifi- 
cance and  effect. 

Let  the  railroad  men  strike,  however,  and,  as 

1877  and  1894  showed,  the  entire  country  feels 

the  blow.     Every  class,  every  community,  every 

business,  is  affected.     The  four  Railway  Brother- 

127 


THE  CAREFUL  INVESTOR 

hoods  hold  in  their  hands  the  prosperity  of  the 
United  States.  Because  they  possess  a  monopoly 
of  the  skilled  labor  necessary  to  conduct  the  busi- 
ness of  transportation,  they  have  the  power  to 
cripple  every  business  in  the  country.  Skilled 
railway  operators  cannot  be  replaced  by  non-union 
men.  For  locomotive  engineers  or  firemen  there 
are  few  substitutes.  If  they  cease  to  labor,  the 
trains  cease  to  move,  commerce  comes  to  a  stand- 
still, factories  close,  business  staggers  and  stops. 
The  effect  of  the  suspension  of  cash  payments  by 
the  banks  in  1907  is  still  remembered.  The  situa- 
tion at  that  time  gave  but  a  faint  indication  of  the 
damage  which  the  country  would  sustain  by  the 
suspension  of  the  railroads. 

Railway  managers  know  this.  Railway  em- 
ployees know  this.  In  every  controversy  over 
wages,  hours  of  employment,  or  working  condi- 
tions, the  unique  position  of  the  railway,  as  an 
indispensable  public  servant,  and  the  extraordi- 
narily powerful  position  of  the  employee  of  that 
public  servant,  are  present  in  the  minds  of  the 
contestants.  Such  a  contest  is  unequal.  The  men 
have  all  the  advantage.  They  can  throw  the  rail- 
roads into  bankruptcy  and  the  country  into  ruin, 
and  they  know  it.     They  know  further  that  the 

128 


RAILWAY  LABOR.  AND  INVESTMENT 

railway  managers  will  not  be  allowed  by  public 
opinion,  even  if  their  own  dispositions  set  in  this 
direction,  to  force  the  issue.  They  must  make 
concessions;  they  must,  in  every  contest,  yield 
something.  All,  therefore,  that  is  required  is  for 
the  men  to  return  again,  and  yet  again,  with  ever- 
increasing  demands,  and  they  can  obtain  the  entire 
surplus  revenue  of  the  railroad. 

I  do  not  claim  that  the  railway  employees  will 
carry  their  demands  to  this  extent,  or  that  the 
desire  to  confiscate  the  dividends  of  the  railway 
stock-holders  has  ever  entered  the  minds  of  their 
leaders.  They  have  it  in  their  power,  however, 
to  advance  their  wages  to  the  point  where  the 
present  scale  of  dividends  can  no  longer  be  main- 
tained. When  Lord  Clive,  on  his  return  from 
India,  was  accused  in  the  House  of  Commons  of 
the  practice  of  extortion,  he  replied,  "Sir,  when  I 
think  what  I  might  have  taken,  I  am  astonished 
at  my  own  moderation."  With  equal  justice,  the 
Railway  Brotherhoods  can  point  to  the  evidence 
of  their  moderation  in  the  fact  that  the  railroads 
can  still  pay  dividends  and  lay  aside  something  for 
their  surplus  accounts. 

This  situation  is,  however,  fraught  with  possi- 
bilities of  peril.  So  far  as  the  Interstate  Commerce 
g  129 


THE  CAREFUL  INVESTOR 

Commission  is  concerned,  the  railroads  have  little 
to  fear.  If  the  Commission  will  not  sanction  a 
general  advance  in  rates,  it  is  unlikely  that  it  will 
order  their  general  reduction.  Railway  rates,  the 
products  of  innumerable  adjustments  and  com- 
promises, tend  constantly  to  stability.  Each  year 
the  difficulty  of  change,  because  of  the  wider- 
reaching  consequences  of  change,  becomes  greater. 
Adjustments  between  localities  and  classes  of 
traffic,  reductions  in  special  cases,  may  be  made; 
but  the  danger  of  a  general  reduction  in  rates 
which  shall  affect  earnings  is  slight. 

It  is  not  so  with  the  labor  situation.  Here  the 
representatives  of  organized  labor  have  set  no 
limit  to  their  demands,  short  of  the  utmost  ability 
of  the  railroads  to  pay.  Railway  wages,  in  their 
opinion,  will  never  be  high  enough.  They  are 
willing  to  endorse  the  railroads'  demands  for 
higher  rates,  out  of  which  higher  wages  might  be 
paid,  and,  in  fact,  this  proposition  has  been  seri- 
ously advanced  by  some  of  their  leaders.  They 
will  not,  however,  concede  that  railway  wages  can 
be  limited,  that,  for  example,  the  locomotive  engi- 
neer should  be  restricted  to  a  maximimi  of  $So 
per  month,  a  salary  upon  which  he  can  purchase 
his  house  and  send  his  children  to  the  high  school. 

130 


RAILWAY  LABOR  AND  INVESTMENT 

They  desire  that  his  wages  should  rise  to  $250 
per  month,  upon  which  he  can  send  his  children 
to  college.  No  matter  how  high  railway  wages  go, 
they  are  still  too  low,  in  the  opinion  of  the  railway 
employee,  for  his  necessities,  his  responsibilities 
and  his  deserts. 

And,  after  all,  if  only  these  demands  can  be 
reconciled  with  the  necessities  of  the  country  for 
a  full  development  of  its  resources,  and  with  the 
just  claims  of  the  railroad  stock-holders  and  credi- 
tors, why  shotdd  the  railway  employee  be  denied 
his  wish  to  rise  to  a  higher  plane  of  existence? 
Every  day  millions  of  people  trust  their  lives  to 
the  men  who  run  the  trains,  walk  the  tracks,  and 
operate  the  signals  and  switches.  What  compen- 
sation will  be  considered  too  much  for  the  faithful 
performance  of  this  trust?  What  public  servant 
has  a  more  responsible  position  than  the  locomo- 
tive engineer?  Who  has  charge  of  a  larger  amount 
of  property?  Upon  whose  competence  and  vigil- 
ance depend  so  large  a  number  of  human  lives  ? 

Let  us  come  to  the  issue  of  the  question :  How 
can  the  demands  of  the  railway  men  be  met; 
demands  which  they  apparently  have  present 
power  to  enforce;  however  gradually,  with  what- 
ever degree  of  conservatism  they  go  about  en- 

131 


THE  CAREFUL  INVESTOR 

forcing  them ;  while  at  the  same  time  the  needs  of 
the  country  for  additional  capital  may  be  satis- 
fied ?  Under  present  conditions,  the  profits  of  the 
railroads,  present  and  prospective,  large  though 
they  are,  are  not  large  enough  to  induce  a  sufficient 
amount  of  investment  to  meet  the  national  require- 
ments. The  country  has  had  abundant  proof  that 
in  recent  years  sufficient  money  has  not  been  spent 
upon  railway  facilities.  Unless  the  outlook  for 
railway  profits  becomes  more  favorable,  these 
facilities  will  become  increasingly  inadequate. 

What,  then,  is  to  be  done?  Shall  rates  be  ad- 
vanced to  permit  the  payment  of  higher  wages? 
How  will  this  mend  matters?  If  rates  go  up  and 
wages  rise  with  them,  shippers  and  consumers  are 
burdened  and  railway  credit  is  not  improved.  It 
is  by  following  no  such  vicious  circle  that  the  solu- 
tion of  the  problem  is  to  be  found.  The  United 
States  will  never  reach  a  permanent  solution  of  its 
transportation  problem  until  railway  labor  can 
be  brought  to  realize  and  recognize  by  its  acts 
that  the  railroads  are  entitled — in  the  words  of 
the  Supreme  Court — "To  a  reasonable  return 
upon  a  fair  value  of  their  property  employed  in 
the  public  service."    This  reasonable  return  is  not 

to  be  the  rate  of  interest  on  the  best  first  mort- 

132 


RAILWAY  LABOR  AND  INVESTMENT 

gages;  but  such  a  rate  of  profit,  averaging  good 
years  with  bad,  as  will  attract  capital  into  rail- 
road securities.  More  than  this  the  railroad  stock- 
holder does  not  and  should  not  claim;  less  than 
this  means  an  arrested  railway  development,  a 
slow  and  halting  industrial  development,  a  condi- 
tion of  prolonged  business  stagnation,  broken  only 
by  fitful  gleams  of  temporary  prosperity. 


XI 

"A  REASONABLE  RETURN  UPON  THE 

VALUE  OF  THE  PROPERTY  DEVOTED 

TO  THE  PUBLIC  SERVICE" 

In  the  words  which  form  the  title  to  this  Chap- 
ter, Mr.  Charles  A.  Prouty,  speaking  for  the 
Interstate  Commerce  Commission,  on  February  22, 
191 1,  stated  the  problem  presented  to  the  Commis- 
sion by  the  petition  of  the  Trunk  Lines  that  they 
should  be  allowed  to  advance  their  rates.  * '  We  are 
to  determine,"  said  the  Commission,  "whether  the 
net  return  of  these  carriers  upon  the  value  of  their 
property  devoted  to  the  public  service  will  be 
sufficient  without  an  advance  in  their  rates." 

After  an  exhaustive  review  of  the  testimony 
presented  on  behalf  of  and  against  the  railroads, 
the  Commission  reached  the  conclusion  that  these 
defendants  have  not  established  such  a  need  for 
additional  revenue  as  justifies,  at  this  time,  an 
increase  in  these  rates.  This  decision  was,  how- 
ever, without  prejudice  to  the  railroads. 

It  has  been  several  times  stated  in  the  course  of  this  discussion 
that  in  view  of  the  complex  character  of  this  problem,  nothing 
but  an  actual  test  can  satisfactorily  determine  the  financial  re- 

134 


A  REASONABLE  RETURN 

suits  from  the  operations  of  these  several  carriers.  There  is  no 
evidence  before  us  which  estabHshes  the  necessity  for  higher  rates. 
The  probability  is  that  increased  rates  will  not  be  necessary  in 
the  future.  In  view  of  the  liberal  returns  received  by  these 
defendants  in  the  past  ten  years,  they  should  be  required  to  show, 
with  reasonable  certainty,  the  necessity  before  the  increase  is 
allowed.  If  actual  results  should  demonstrate  that  our  forecast 
of  the  future  is  wrong,  there  might  be  ground  for  asking  a  further 
consideration  of  this  subject. 

The  railroads  have  again  petitioned  to  be  al- 
lowed to  make  a  five  per  cent,  advance  in  all  rates 
in  Official  Classification  Territory,  north  of  the 
Ohio  and  east  of  the  Mississippi  rivers,  an  advance 
equivalent  to  a  $40,000,000  increase  in  net  rev- 
enues. If  their  officials  were  not  convinced  that 
the  "actual  test"  asked  for  by  the  Commission 
had  demonstrated  that  the  Commission  was  wrong, 
the  railroads  would  not  make  attempt  to  increase 
their  rates.  What,  then,  is  the  nature  of  this 
experience  of  the  last  three  years,  upon  which  the 
railroads  must  rely  if  they  are  to  induce  the  Com- 
mission to  reconsider  its  decision  of  191 1  ? 

This  question  must  be  answered  with  reference 
to  the  evidence  and  reasoning  upon  which  the 
Commission's  former  refusal  was  based.  In  sub- 
stance this  was  as  follows:  The  Pennsylvania, 
Baltimore  and  Ohio,  and  New  York  Central  are 

typical  trunk-line  railroads.     Their  freight  rev- 

135 


THE  CAREFUL  INVESTOR 

enues  were  nearly  one-half  of  the  total  freight 
revenue  in  Official  Classification  Territory. 
"Whatever  rate  might  reasonably  be  imposed  upon 
these  three  systems  must  be  held  to  be  a  reason- 
able charge  for  that  service  by  all  hnes." 

The  Commission  defined  a  reasonable  return 
upon  the  property  of  these  three  companies  to  be 
a  margin  of  profits  equivalent  to  certain  earnings 
upon  their  common  stocks.  For  the  Baltimore 
and  Ohio,  it  was  held  that  "the  sum  remaining 
after  fixed  charges,  including  as  a  fixed  charge  the 
dividend  upon  the  preferred  stock,  should  be 
equivalent  to  between  7  and  8  per  cent,  upon  the 
common  stock,"  or  about  $2,280,000 — 1>^  per 
cent,  on  the  present  common  stock.  For  the 
Pennsylvania,  a  margin  of  $18,000,000  over  com- 
mon-stock dividends  was  held  not  to  be  unreason- 
able. For  the  New  York  Central,  the  Commission 
found  that,  after  allowing  for  an  expected  increase 
in  operating  expenses  due  to  the  higher  wage  scale 
which  went  into  effect  in  19 10,  the  Company  could 
pay  its  6  per  cent,  dividends  with  about  $1,500,000 
to  spare.  For  several  reasons;  an  admitted  infla- 
tion of  the  capital  of  the  constituent  companies  and 
of  the  New  York  Central  at  the  time  of  the  consoH- 
dation  in  1869,  amounting  to  $57,000,000,  on  which 

136 


A  REASONABLE  RETURN 

stock  issued  without  consideration  to  the  company, 
$120,000,000  in  dividends  had  been  paid,  and  not 
omitting  to  mention  the  fact  that  the  New  York 
Central  was  burdened  with  unprofitable  leases, 
losses  on  which  the  public  should  not  be  expected  to 
make  up  to  its  stockholders  in  higher  rates,  and 
having  regard,  finally,  to  the  exceptionally  strong 
position  of  certain  of  the  New  York  Central's  sub- 
sidiaries, the  Commission  reached  the  conclusion 
that  this  margin  of  $1,500,000  over  the  dividend 
requirement  was  not  so  small  as  to  warrant  an 
increase  of  freight  rates  in  order  to  increase  it. 

We  have,  then,  this  standard  by  which  to  deter- 
mine the  reasonableness  of  rates  in  Official  Classi- 
fication Territory.  If  it  appears  that  existing  rates 
now  yield  these  three  companies  substantially  less 
than  the  amount  of  profits  which  the  Interstate 
Commerce  Commission,  in  191 1,  declared  to  be 
reasonable,  then  the  carriers  will  have  established 
their  case.  If,  on  the  other  hand,  the  dividends 
of  these  three  typical  companies,  notwithstanding 
higher  operating  costs  and  increased  fixed  charges, 
are  still  protected  by  the  same  relative  margins  of 
safety  as  those  which  the  Commission  considered 
adequate  in   191 1,   then  the  railroads  have  lost 

their  case  before  they  open  it. 

137 


THE  CAREFUL  INVESTOR 

The  facts  of  railway  profits  for  the  last  year  for 
which  statistics  are  available  are  as  follows  for 
each  of  the  three  companies  under  examination : 

Pennsylvania  Railroad  Company — Year  Ending  December  31, 
1912: 

Net  Income $42,153,964 

Dividends  6  per  cent 27,198,918 

Balance $14,955,046 

Baltimore  and  Ohio — Year  Ending  June  30,  1912: 
Balance  of  Net  Income  or  for  Preferred  Divi- 
dends   $11,543,000 

Dividends  on  common  6  per  cent 9,121,073 

Balance $  2,421,927 

New  York  Central  and  Hudson  River  Railroad — Year  Ending 
December  31,  1912: 

Balance  of  Net  Income  over  all  charges $13,879,837 

Dividends  (5  per  cent.) 11,136,465 

Balance $  2,743,372 

Amount  required  to  pay  6  per  cent.,  the  stand- 
ard accepted  by  the  Commission  in  1911 . .  $13,563,558 
Balance — over  6  per  cent 316,279 

Summarized,  these  results  are  as  follows : 

Balance  of  Net  Earnings  over  charges  accepted  by  the  Commis- 
sion as  standard  in  191 1 : 

Baltimore  and  Ohio $  2,280,000 

Pennsylvania 18,000,000 

New  York  Central 1,500,000 

Balance  of  Net  Earnings  over  charges  for  last  fiscal  year: 

Baltimore  and  Ohio $  2,421,927 

Pennsylvania 14.955.9^8 

New  York  Central 316,279 

138 


A  REASONABLE  RETURN 

I'^rom  these  figures  it  appears  that,  measured 
by  the  standard  accepted  by  the  Interstate  Com- 
merce Commission,  the  Baltimore  and  Ohio  is  in 
about  the  same  relative  position  as  in  1910,  the 
New  York  Central  has  suffered  a  severe  decline 
in  its  margin  of  safety,  and  the  margin  of  safety 
of  the  Pennsylvania  has  seriously  decreased. 

On  the  basis  of  the  Commission's  reasoning  in 
191 1,  and  taking  no  account  of  changes  in  condi- 
tions affecting  the  railroads  since  that  time,  the  car- 
riers are  evidently  entitled  to  an  increase  in  rates. 

It  is  also  possible  to  advance  additional  argu- 
ments in  support  of  the  railroad's  contention, 
based  on  alleged  changes  in  conditions  affecting 
the  railroads  since  1910. 

Operating  expenses  have  rapidly  increased,  out- 
stripping the  substantial  gains  in  gross  earnings. 
For  this  the  demands  of  organized  labor  are  mainly 
responsible  and  these  show  no  signs  of  abatement. 

The  investment  situation  is  not  satisfactory. 
Weak  companies  are  continually  facing  financial  dif- 
ficulties. Some  companies,  hitherto  reported  strong, 
have  been  shown  to  be  extremely  weak .  Many  strong 
companies  are  turning  from  one  emergency  expe- 
dient to  another  in  the  attempt  to  finance  their  ma- 
turing obligations.   Railroads  must  apparently  pay 

139 


THE  CAREFUL  INVESTOR 

five  per  cent,  for  money,  and  until  the  international 
financial  situation  clears,  they  may  have  difficulty 
in  filling  their  requirements,  even  at  that  high  figure. 

Public  regulation  is,  moreover,  growing  more 
exacting.  Greater  safety  in  travel,  improved 
working  conditions  and  shorter  hours  for  em- 
ployes, the  provision  of  improved  facilities  for 
shippers,  such  regulations  are  becoming  universal, 
and  each  one  adds  to  the  cost  of  railway  opera- 
tion. The  railroads  have  suffered,  in  common 
with  all  industries,  from  the  rising  prices  of  their 
operating  supplies,  of  which  coal  is  the  most  im- 
portant. Their  costs  of  construction  and  repair 
have  also  greatly  increased  for  the  same  reason. 

On  the  other  hand,  it  is  possible  to  advance 
some  considerations  on  behalf  of  the  shippers  and 
against  the  increase  of  rates.  The  method  fol- 
lowed by  the  Interstate  Commerce  Commission 
takes  account  only  of  the  profits  of  companies,  dis- 
regarding the  profits  of  groups  of  companies.  Back 
of  the  New  York  Central,  for  example,  is  a  group  of 
wealthy  and  prosperous  subsidiaries,  which  have 
earned  far  more  than  they  have  paid  to  the  parent 
company  in  dividends.  The  same  is  true  of  the 
Pennsylvania.  Again,  the  present  stringency  in  the 
investment  market  is  not  permanent.  Railway  se- 

140 


A  REASONABLE  RETURN 

curities  will  improve  in  market  and  price,  especially 
after  the  companies,  as  the  Pennsylvania  is  now 
doing,  have  reorganized  their  capital  accounts  by 
creating  general  refunding  mortgages  under  which 
bonds  of  a  kind  acceptable  to  investors  can  be  sold. 

It  has  not  been  shown  that  railway  efficiency  has 
reached  the  practicable  maximum.  Indeed  recent 
investigations  of  the  New  Haven  and  Hartford 
show  that  efficiency  can  be  largely  increased. 

Finally,  it  does  not  appear  that  the  railroads 
would  be  allowed  to  retain  the  $40,000,000  which 
is  the  estimated  amount  of  the  yield  from  the  in- 
crease in  rates  in  Official  Classification  Territory. 
Railway  labor  is  not  yet  satisfied,  and  assess- 
ments upon  railway  property  are  steadily  advanc- 
ing. The  final  result  might  be  that  the  shipper  has 
made  a  substantial  contribution,  not  to  the  rail- 
roads, but  to  the  railway  employes  and  to  the  State. 

Before  the  increase  in  rates  is  granted,  the  en- 
tire subject  of  the  financial  situation  of  the  rail- 
roads will  be  carefully  investigated  by  the  Inter- 
state Commerce  Commission.  It  is  to  be  hoped 
that  the  result  of  this  investigation  will  be  the 
formation  of  some  conclusions  and  standards  of 
permanent  value  in  the  determination  of  what 
constitutes  a  reasonable  railway  rate. 

141 


XII 


THE    SECURITIES    OF    PUBLIC-SERVICE 
CORPORATIONS 

The  public-service  corporation  is  so-called  be- 
cause it  supplies  a  service  or  a  commodity  to  the 
entire  population  of  a  community.  As  an  aid  to 
the  performance  of  this  public  service,  it  is  allowed 
to  occupy  the  public  streets  and  other  public  prop- 
erty vnth  pipes,  wires,  or  tracks,  under  a  grant  of 
authority  from  the  municipality  known  as  the 
franchise.  Examples  of  public-service  corporations 
are  street-railway  companies,  telephone  and  tele- 
graph, gas,  water,  and  lighting  companies.  Steam 
railroads,  interurban  electric  railroads,  and  water- 
power  companies  are  sometimes  included  in  this 
classification. 

The  securities  of  public-service  corporations 
present  desirable  opportunities  to  the  investor. 
Public-service  corporations  operate  in  industries 
which  are  very  profitable,  and  whose  profits  are 
rapidly  increasing.  Furthermore,  owing  to  the 
long-standing  prejudice  of  the  largest  investors 
against  these  securities,  a  prejudice  only  recently 

142 


PUBLIC-SERVICE  CORPORATIONS 

overcome,  they  can  still  be  purchased  at  prices 
which  yield  between  five  and  six  per  cent. 

It  is  important  to  understand  why  the  public- 
service  industries  are  so  exceptionally  prosperous. 
The  fact  must  be  admitted.  In  Philadelphia,  for 
example,  the  underlying  companies  of  the  street- 
railway  system  pay  extraordinary  dividends.  The 
Union  Passenger  Railway,  for  example,  pays  19  per 
cent,  on  its  stock,  the  Thirteenth  and  Fifteenth 
Passenger  Railway  24  per  cent.,  and  the  Frank- 
ford  and  South wark  34  per  cent.  These  are  the 
original  underlying  companies.  While  an  enor- 
mous investment  has  been  made  in  their  property 
by  each  of  the  three  companies  which  have  suc- 
ceeded them  in  the  development  of  the  street- 
railway  system  of  Philadelphia,  yet  the  large 
dividends  earned  by  the  underiying  companies 
give  a  good  idea  of  the  profits  of  street-railway 
operation  in  a  large  city.  The  same  may  be  said 
of  gas,  water,  telephone,  and  electric  light  and 
power  companies.  In  all  large  cities,  these  enter- 
prises are  exceedingly  profitable. 

This  statement  is  made  to  refer  to  large  cities 
because  it  is  only  in  the  large  city  that  the  opera- 
tion of  the  law  of  increasing  returns  in  public- 
service  industry  has  reached  its  full  development. 

143 


THE  CAREFUL  INVESTOR 

In  small  cities  and  towns,  public-service  industries 
are  no  more  prosperous  than  any  other. 

The  operation  of  the  law  of  increasing  returns 
may  be  illustrated  from  the  street-railway  indus- 
try. Street-railway  operation  involves  the  main- 
tenance of  regular  and  frequent  schedules  for  the 
service  of  the  public.  It  costs  but  little  more  to 
operate  a  full  car  than  a  car  half  full  or  empty. 
Up  to  the  capacity  of  the  tracks  in  the  congested 
districts,  and  up  to  the  generating  capacity  in  the 
power-houses,  additional  cars  may  be  added  to 
accommodate  the  increase  of  traffic  with  a  com- 
paratively small  increase  in  the  expense. 

The  operating  expenses  of  every  business  include 
certain  items  which  are  comparatively  fixed,  and 
certain  other  items  which  increase  and  diminish 
with  the  volume  of  business.  A  street-railway 
corporation,  for  example,  makes  a  certain  invest- 
ment in  tracks,  overhead  work,  power  houses,  car- 
bams,  equipment,  and  cars.  Out  of  the  revenues 
from  the  operation  of  this  property,  it  must  earn 
enough  to  pay  interest  on  its  plant,  to  keep  it  in 
repair,  and  to  provide  for  its  replacement  when  it 
is  worn  out.  It  must  also  buy  fuel  and  other 
supplies,  and  employ  a  large  number  of  men  in 
operating  its  power-house  and  in  keeping  its  plant 

144 


PUBLIC-SERVICE  CORPORATIONS 

in  repair.  It  has  an  expensive  executive  and  legal 
staff.  It  employs,  if  located  in  a  large  city,  several 
thousand  motormen  and  conductors.  Out  of  every 
five  cents  which  the  passenger  pays,  provision 
must  be  made  for  all  of  these  charges — so  much  for 
interest,  for  depreciation,  for  maintenance,  and 
for  operation  of  the  cars. 

The  larger  the  number  of  people  transported  by 
this  plant  within  a  given  time,  the  smaller  will  be 
the  share  of  these  total  expenses  which  must 
be  borne  by  each  passenger,  and  the  larger  will 
be  the  fraction  of  the  five-cent  fare  which  will 
remain  to  the  company  as  its  profit.  Up  to  the 
capacity  of  its  plant,  in  other  words,  each  addi- 
tional thousand  passengers  transported  by  the 
street-railway  company  means  a  division  of  the 
total  operating  expenses  among  a  larger  number 
of  riders,  and  an  increase  in  the  profit  which  the 
company  takes  out  of  each  nickel  which  the  pas- 
sengers pay. 

When  the  capacity  of  the  plant  has  been  reached, 

and  it  becomes  necessary  to  supplement  surface 

street-railway  lines  costing  $60,000  per  mile,  with 

elevated  lines  costing  $500,000  per  mile,  or  subway 

tunnels  costing  $2,000,000  per  mile,  then  the  profits 

are  by  no  means  so  great,  because  the  fixed  charges 
10  145 


THE  CAREFUL  INVESTOR 

have  been  enormously  increased.  As  soon  as  this 
replacement  has  been  made,  however,  and  the 
traffic,  in  response  to  the  improved  facilities,  begins 
again  to  increase,  the  law  of  increasing  returns 
again  comes  into  operation,  and  up  to  the  capacity 
of  the  new  and  enlarged  plant,  each  additional 
thousand  passengers  means  an  increase  in  the 
margin  of  profit  in  each  passenger's  fare. 

The  same  law  controls  the  expenses  and  profits 
of  gas,  water,  and  lighting  companies.  As  the 
population  which  they  serve  increases,  and  the 
volume  of  their  business  grows,  it  has  been  found 
that  they  can  supply  this  increased  demand  for 
long  periods  without  materially  increasing  their 
plant,  and  with  comparatively  slight  increases  in 
operating  expenses. 

Another  feature  of  the  demand  for  the  commod- 
ities or  service  furnished  by  public-service  cor- 
porations is  that  not  only  does  it  increase  with 
the  growth  of  population,  but  that  it  increases 
faster  than  the  population  grows.  The  reason  for 
this  can  be  readily  understood  in  the  case  of  the 
street  railway.  As  the  population  of  a  city  grows, 
land  values  and  rentals  in  the  downtown  sections 
rapidly  increase.  Population,  both  because  of  the 
lower  rents  in  the  suburbs,  and  also  because  of 

146 


PUBLIC-SERVICE  CORPORATIONS 

the  cheapness  and  convenience  of  transportation 
which  the  street  railway  furnishes,  moves  from  the 
central  sections  to  the  outlying  sections.  This 
means  that  a  great  number  of  people  live  several 
miles  from  their  work,  to  which  they  must  go  six 
mornings  a  week,  and  from  which,  six  evenings  a 
week,  they  must  return.  The  larger  the  popula- 
tion grows,  the  larger  becomes  this  movement  to 
the  outlying  sections  and  the  stronger  the  demand 
for  transportation.  The  central  portion  of  the 
city  is  the  natural  location  for  the  large  depart- 
ment stores,  hotels,  theatres,  and  street-railway 
terminals.  These  draw  in  multitudes  of  people 
over  the  street-railway  lines. 

The  same  proportionately  greater  increase  in 
demand,  as  compared  with  the  growth  in  popula- 
tion, is  seen  in  the  gas  industry.  From  1890  to 
1 9 10,  for  example,  the  population  of  the  four 
boroughs  of  New  York  city  increased  90.6  per 
cent,  but  the  consumption  of  gas  increased  164.6 
per  cent.,  nearly  double  the  increase  in  population. 
In  this  field,  the  increase  in  demand  is  due  not 
only  to  the  growth  of  population,  but  to  the  grow- 
ing usefulness  of  gas  in  industrial  work,  as  well  as 
for  cooking,  heating,  and  other  domestic  purposes. 
The  business  of  furnishing  light  and  power  and 

147 


THE  CAREFUL  INVESTOR 

heat  shows  the  same  tendency.  The  investor  in 
the  securities  of  well  managed  public-service  cor- 
porations that  may  be  located  in  a  city  of  at  least 
100,000  population  can  be  reasonably  certain  that 
the  city  will  grow,  and  that  as  it  grows  the  prof- 
its of  his  company  will  increase  at  a  more  rapid 
rate. 

Public-service  corporations  do  not,  as  a  rule, 
divide  their  earnings  with  competitors.  Even 
when  the  city  does  not  give  them  the  exclusive 
right  to  supply  transportation — and  the  policy  of 
our  law  is  opposed  to  exclusive  grants  of  this 
character — the  favorable  conditions  under  which 
their  business  is  carried  on  give  them  a  practical 
monopoly.  The  nature  of  this  monopoly,  as  well 
as  the  advantages  of  an  investment  in  a  public- 
service  corporation  in  a  large  city,  was  clearly  ex- 
pressed by  Mr.  Justice  Peckham  of  the  United 
States  Supreme  Court  in  delivering  the  opinion 
of  the  court  in  the  case  of  Wilcox  vs.  Consolidated 
Gas  Company  of  New  York  as  follows: 

In  an  investment  in  a  gas  company,  such  as  complainants', 
the  risk  is  reduced  almost  to  a  minimum.  It  is  a  corporation, 
•which  in  fact,  as  the  court  below  remarks,  monopolizes  the  gas 
service  of  the  largest  city  in  America,  and  is  secure  against  com- 
petition under  the  circumstances  in  which  it  is  placed,  because 
it  is  a  proposition  almost  unthinkable  that  the  city  of  New  York 

148 


PUBLIC-SERVICE  CORPORATIONS 

would,  for  purposes  of  making  competition,  permit  the  streets  of  tJie 
city  to  be  again  torn  up  in  order  to  allow  the  mains  of  another  com- 
pany to  be  laid  all  through  them  to  supply  gas  which  the  present 
company  can  adequately  supply.  And,  so  far  as  it  is  given  us  to 
look  into  the  future,  it  seems  as  certain  as  anything  of  such  a 
nature  can  be,  that  the  demand  for  gas  will  increase, — and,  at  the 
reduced  price,  increase  to  a  considerable  extent.  An  interest  in 
such  a  business  is  as  near  a  safe  and  secure  investment  as  can  be 
imagined  with  regard  to  any  private  manufacturing  business.  .  . 

In  the  absence  of  legal  restrictions,  a  company 
possessing  a  monopoly  of  a  necessity  of  life  is 
limited  in  its  charges  only  by  what  the  traffic  will 
bear.  If  the  price  of  gas  is  too  high,  the  consump- 
tion will  fall  off,  and  the  expense  of  operation, 
reversing  the  process  which  was  explained  illus- 
trating the  law  of  diminishing  returns,  will  be 
increased.  Interest,  taxes,  maintenance,  depre- 
ciation, executive  expenses,  advertising,  etc.,  will 
be  spread  over  a  smaller  amount  of  production, 
and  the  cost  of  each  thousand  feet  produced  will 
be  correspondingly  increased. 

It  is  to  the  interest  of  a  monopoly  to  lower  the 
price  of  its  product  so  far  as  this  lowering  of  the 
price  will  increase  consumption  and  increase 
profits.  Below  this  point  it  is  not  to  the  interest 
of  the  monopoly  to  go.  If,  for  example,  a  price  of 
Si.oo  per  thousand  feet  will  yield  $6,000,000  of 
revenue,  while  a  price  of  eighty  cents  will  yield  a 

149 


THE  CAREFUL  INVESTOR 

profit  of  only  $5,500,000,  because  the  consumption 
will  not  increase  to  correspond  with  the  reduction 
in  the  price,  the  monopoly,  unless  constrained  by 
law,  will  not  make  the  reduction.  On  the  other 
hand,  if  a  reduction  to  eighty  cents  will  so  much 
increase  the  consumption  as  to  raise  the  profits 
from  $6,000,000  to  $7,000,000,  it  is  to  the  interest 
of  the  monopoly  to  reduce  the  price.  Below  the 
price  at  which  the  largest  profit  will  be  realized, 
a  corporation  having  a  monopoly  of  any  commodity 
or  service,  will  not  willingly  go. 

At  this  point,  in  the  case  of  the  public-service 
corporation,  the  State  steps  in  and  applies  a 
principle  of  profit  regulation  which  is  as  follows: 
A  corporation  operating  in  a  public  service  in- 
dustry supplying  a  necessity  of  life  to  the  com- 
munity, is  entitled  to  profits  equal  to  a  reasonable 
return  on  a  fair  value  of  its  property  which  is 
employed  in  the  public  service.  The  fair  value 
of  property  has  been  determined,  as  a  result  of  a 
long  series  of  judicial  decisions,  to  be  a  combina- 
tion of  the  cost  of  reproducing  and  the  fair  market 
value  of  the  property  at  the  time  the  valuation 
is  made.  The  "reasonable  return"  depends  on 
circumstances.  Again  to  quote  from  the  Con- 
solidated Gas  case: 

150 


PUBLIC-SERVICE  CORPORATIONS 

There  is  no  particular  rate  of  compensation  which  must  in  all 
cases  and  in  all  parts  of  the  country  be  regarded  as  suflBcient  for 
capital  invested  in  business  enterprises.  Such  compensation 
must  depend  greatly  upon  circumstances  and  locality;  among 
other  things,  the  amount  of  risk  in  the  business  is  a  most  impor- 
tant factor,  as  well  as  the  locality  where  the  business  is  conducted 
and  the  rate  expected  and  usually  realized  there  upon  investments 
of  a  somewhat  similar  nature  with  regard  to  the  risk  attending 
them.  There  may  be  other  matters  which  in  some  cases  might 
also  be  properly  taken  into  account  in  determining  the  rate 
which  an  investor  might  properly  expect  or  hope  to  receive,  and 
which  he  would  be  entitled  to  without  legislative  interference. 
The  less  risk,  the  less  right  to  any  unusual  returns  upon  the 
investments.  One  who  invests  his  money  in  a  business  of  a  some- 
what hazardous  character  is  very  properly  held  to  have  the  right 
to  a  larger  return  without  legislative  interference,  than  can  be 
obtained  from  an  investment  in  Government  bonds  or  other  per- 
fectly safe  security.  The  man  that  invested  in  gas  stock  in  1823 
had  a  right  to  look  for  and  obtain,  if  possible,  a  much  greater 
rate  upon  his  investment  than  he  who  invested  in  such  property 
in  the  city  of  New  York  years  after  the  risk  and  danger  involved 
had  been  almost  entirely  eliminated. 

In  this  case,  the  court  found  that  since  the  gas 

business  was  probably  the  safest  of  manufacturing 
industries,  since  the  Consolidated  Gas  Company 
possessed  a  monopoly,  and  since  its  future  was 
reasonably  assured,  a  return  of  6  per  cent,  would 
be  sufficient,  and  that  a  price  of  eighty  cents  per 
thousand  feet  for  gas  would  yield  this  return. 

Starting  at  6  per  cent,  as  a  "reasonable  return" 
in  the  safest  public-service  corporation,  we  go  up 
in  the  scale  according  to  circumstances.     For  ex- 

161 


THE  CAREFUL  INVESTOR 

ample,  the  "reasonable  return"  for  the  Great 
Northern  and  Northern  Pacific  railroads  in  a 
recent  court  decision  was  held  to  be  7  per  cent., 
and  it  is  not  to  be  doubted  that  whenever  the 
matter  comes  before  the  courts  for  determination 
the  rate  which  the  public  service  corporations  will 
be  allowed  to  earn  will  be  fixed  according  to  the 
circumstances  of  the  industry,  and  of  the  particular 
company  in  question.  A  10  per  cent,  return 
might  be  reasonable  for  a  street-railway  company 
in  a  small  city,  while  it  would  be  exorbitant  for  a 
street  railway  in  a  metropolis. 

The  development  of  this  theory  that  the  public- 
service  corporation  is  entitled  to  no  more  than  a 
"reasonable  rate  of  return,"  while  attended  with 
serious  misgiving  on  the  part  of  bankers  and  in- 
vestors when  it  first  came  into  active  application, 
is  now  regarded  as  one  of  the  greatest  safeguards 
which  the  investor  in  these  securities  can  have. 
The  pubHc-service  corporation  is  by  its  nature  a 
monopoly.  If  the  company  is  properly  capitahzed, 
if  the  plant  is  properly  constructed  and  managed, 
and  if  ordinary  business  judgment  has  been  used 
in  fitting  the  capacity  of  the  plant  to  the  demand 
for  its  product  or  service,  the  returns  to  the  in- 
vestor are  certain,   because  the  law  allows  the 

U2 


PUBLIC-SERVICE  CORPORATIONS 

charging  of  rates  which  will  yield  a  "reasonable 
return"  on  the  capital  invested.  Of  no  other 
department  of  investment  is  this  true.  The  inves- 
tor in  mining  securities,  real-estate  securities, 
industrial  securities  of  all  kinds,  is  not  given  any- 
thing by  the  law.  He  must  take  his  chances.  He 
has  not  the  advantage  of  a  monopoly.  If,  as  the 
trusts  attempted  to  do,  these  enterprises  unite  to 
obtain  monopolistic  power,  the  law  is  invoked 
against  them,  and  these  illegal  combinations  are 
broken  up.  The  public-service  corporation,  how- 
ever, is  a  monopoly,  and  the  law  protects  it  in  the 
enlargement  of  its  monopolistic  profits  up  to  a 
point  of  a  "reasonable  return"  which,  as  has  been 
explained,  is  quite  sufficient  to  satisfy  the  investor. 


XIII 

THE    INVESTMENT-BANKER    AND    THE 
PUBLIC-UTILITY  COMPANY 

Bonds  of  public-service  corporations  can  fre- 
quently be  bought  to  yield  5  to  5K  per  cent,  to  the 
investor.  These  high  yields  inspire  caution.  They 
raise  a  presumption  against  the  issue.  Cautious 
investors  discriminate  against  high-yield  bonds. 
High-interest  rates  and  lower  prices — are  they  not 
indications  of  lack  of  demand  for  these  securities? 
And  is  not  the  explanation  of  this  weaker  demand  a 
higher  percentage  of  failures  in  this  field  than  with 
the  railroads?  The  investment-banker  does  not 
waste  time  in  direct  answers  to  these  questions. 
He  backs  up  his  offerings  of  public-service  bonds 
by  detailed  evidence  of  their  worth,  obtained  by  in- 
vestigation of  every  factor  influencing  their  value. 

The  first  step  in  offering  an  issue  of  public- 
service  company  bonds,  is  to  investigate  the  busi- 
ness basis  of  the  proposition,  which  is  found  in  the 
territory  served.  Only  large  cities  or  groups  of 
small  cities,  united  for  all  business  purposes,  are 
considered  by  the  best  houses  for  direct  offering. 
When  gas,  water,  electric  light,  or  transportation 

154 


THE  PUBLIC-UTILITY  COMPANY 

securities,  issued  by  companies  serving  small  towns, 
are  offered,  the  usual  method  is  to  combine  them 
under  a  collateral  trust  mortgage,  so  that  a  large 
issue  of  bonds,  each  with  the  same  security,  may  be 
offered.  I  have  before  me  a  description  of  an  issue 
of  this  character,  $9,000,000  in  amount,  secured  by 
twelve  issues  of  bonds,  sundry  notes,  and  fourteen 
issues  of  stocks.  These  securities  have  a  market 
value  of  about  $22,000,000,  and  return  more  than 
three  times  the  interest  on  the  $9,000,000  bonds. 
Great  difficulty  would,  however,  be  met  in  selling 
them  separately,  because  of  the  limited  market 
which  would  be  open  to  each.  The  holding  company, 
of  which  this  is  an  illustration,  is  useful  in  making  a 
market  for  securities  of  small  companies,  which 
would  otherwise  be  imsalable  at  reasonable  prices. 
The  banker  prefers,  however,  direct  offerings 
of  bonds  secured  not  by  the  pledge  of  these  pieces 
of  paper  issued  by  smaller  companies,  but  by  the 
pledge  of  property.  So  far  as  he  is  governed  by 
this  preference,  he  must  confine  his  operations  to 
the  larger  cities,  for  nowhere  else  can  he  find  the 
conditions  of  perfect  security  and  reasonable  cer- 
tainty of  appreciation  in  value  which  he  desires. 
His  offering  is  made  stronger  if  the  security  in- 
cludes a  large  amount  of  surrounding  territory, 

155 


THE  CAREFUL  INVESTOR 

but  the  foundation  must  be  the  dense  and  growing 
population  of  the  city.  Great  importance  is  placed 
by  the  banker  upon  the  growth  of  the  city  under 
examination,  not  only  its  past  growth  in  popula- 
tion, but  its  future  as  a  manufacturing,  railroad, 
and  commercial  centre.  For  example,  note  the 
following  vital  facts  concerning  Seattle,  furnished 
in  connection  with  a  recent  bond-offering. 

In  1880  the  population  of  Seattle  was  3,535;  in  1890,  42,837; 
in  1900,  80,671.  At  present  the  estimated  population  is  265,000. 
From  1903  to  1907  the  taxable  valuation  of  the  city  rose  from 
156,674,000  to  $156,531,724,  and  bank  clearings  from  $206,913,- 
000  to  $488,591,000.  During  the  past  six  years,  the  building 
permits  have  increased  300  per  cent.,  and  the  value  of  real-estate 
transfers  over  600  per  cent.  The  Great  Northern  and  the  North- 
ern Pacific  Railway  systems  have  terminals  in  Seattle,  and  the 
Canadian  Pacific  enters  the  city.  The  Chicago,  Milwaukee  and 
St.  Paul  is  building  to  Seattle,  and  the  Union  Pacific  is  planning 
an  entrance  from  the  south.  The  harbor  is  excellent.  The  aggre- 
gate commerce  of  the  port  in  1907  was  $140,472,821.  The  trade 
with  the  Orient  and  with  Alaska,  already  large,  is  rapidly  increas- 
ing. Seattle  is  600  miles  nearer  Yokohama  than  San  Francisco, 
and  the  natural  gateway  for  Alaskan  trade.  Numerous  industries 
are  established  in  the  city,  which  has  become  undoubtedly  the 
most  important  business  and  distributing  centre  on  the  North 
Pacific  Coast,  and,  in  fact,  one  of  the  great  cities  of  the  country. 

When  such  statements  can  be  made  concerning 

a  city,  and  if  other  conditions  affecting  security 

can  be  satisfactorily  met,  bonds  secured  by  a  lien 

on  its  public-service  corporation  property  are  as 

safe  as  the  best  railroad  bonds. 

156 


THE  PUBLIC-UTILITY  COMPANY 

Assuming  that  the  business  basis  of  the  company 
is  sound,  the  next  step  in  the  investigation  is  the 
engineer's  examination.  Every  banking  house  of 
standing  has  engineering  connections,  and  large 
sums  are  often  paid  for  exhaustive  reports.  The 
engineer's  examination  covers  the  condition  of  the 
plant  in  reference  to  maintenance  and  operating 
efficiency;  the  quality  of  the  management,  espe- 
cially as  to  its  demonstrated  ability  to  cultivate 
amicable  relations  with  the  public;  and  the  rates 
charged.  If  these  rates  are  higher  than  those 
generally  prevailing  in  the  State,  or  higher  than 
sufficient  to  yield  a  reasonable  return  upon  the 
investment,  they  are  likely  to  be  reduced;  and  the 
bond-issue  must  be  limited  accordingly.  The 
engineer  also  makes  a  careful  appraisal  of  the  cost 
of  replacing  the  physical  property  of  the  company, 
since  this  sum  represents  the  figure  on  which  the 
courts  will  always  allow  a  reasonable  return.  The 
engineer  often  goes  so  far  as  to  criticise  the  policy 
of  the  management,  to  suggest  plans  for  improve- 
ment in  service,  and  to  point  out  ways  in  which  the 
company's  business  can  be  expanded.  His  report 
is  a  document  often  hundreds  of  pages  in  length, 
which  gives  the  banker  a  complete  picture  of  the 
property  and  business  which  he  is  asked  to  finance. 

157 


THE  CAREFUL  INVESTOR 

Often,  engineering  firms,  in  order  to  secure  con- 
stant employment  for  their  organizations,  bring 
propositions  to  the  bankers  as  promoters,  and  go 
so  far  as  to  offer  their  cooperation  in  financing 
the  undertaking.  The  tendency  is  now  toward 
such  cooperation  between  bankers  and  engineers. 
A  proposition  submitted  by  an  engineering  con- 
cern of  standing  in  its  field  is  sure  of  respectful 
and  attentive  consideration  from  the  banker,  who 
knows  that  the  engineer's  primary  interest  is  not 
to  take  part  in  the  financing,  but  to  make  his 
regular  percentage  of  engineering  profit.  The  engi- 
neer's interest  may  extend  beyond  the  initial  stages 
of  a  proposition.  He  may  take  charge,  for  a  period, 
of  operating  a  new  concern,  breaking  in  a  perma- 
nent organization,  and  insuring  economical  and 
efficient  management  during  the  trying  first  years. 

Supplementing  the  engineer's  investigation  is 
the  audit  of  the  company's  books.  Banking  houses 
usually  employ  their  own  auditors,  although  they 
often  utilize  the  services  of  public  accountants. 
The  chief  importance  of  the  audit  is  to  make  sure 
that  the  company's  accounts  have  been  properly 
kept.  Many  items  can  be  charged  to  cost  of  con- 
struction which  belong  in  cost  of  operation.     A 

surplus  may  be  created  by  placing  upon  such 

158 


THE  PUBLIC-UTILITY  COMPANY 

intangible  items  as   "franchises"   a  high   value 
which  has  no  substantive  basis. 

The  accountant  looks  closely  to  the  depreciation 
charge.  As  a  recent  writer  on  accountancy  has 
well  said,  "All  machinery  is  on  an  irresistible 
march  to  the  junk-heap."  Provision  must  be 
made  out  of  current  income,  not  only  for  necessary 
current  replacements,  but  to  provide  against  the 
day  when  a  large  part  of  the  plant  will  have  to  be 
renewed.  All  this  information  is  of  the  greatest 
interest  and  value  to  the  banker.  He  wishes  to 
present  to  his  clients  such  a  statement  as  the 
following,  and  to  know  that  it  is  accurate. 

EARNINGS 
(Certified  by  Messrs.  Price,  Waterhouse  &  Company,  Chartered 

Accountants;  and  Allen  Knight,  Esq.,  C.  P.  A.) 
Year  ended  December  31:      1909.  1910.  1911. 

Gross  Earnings $13,491,288    $14,044,596    114,682,669 

Operating  expenses, 
maintenance  and 
taxes 7.531.576        7,921,341        8,151,364 


NET  EARNINGS...  $  5,959,712      $6,123,255    $6,531,305 
Bond  interest  paid 3.278,177 


Balance $  3,253,128 

Gross  earnings  during  the  past  five  years  have  shown  a  steady 
increase,  as  follows: 

1907.  1908.  1909.  1910.  1911. 

$11,342,140    $12,657,305    $13,491,288    $14,044,596    $X4,682,669 

159 


THE  CAREFUL  INVESTOR 

When  the  banker  can  submit  information  of  this 
character,  his  argument  is  convincing. 

The  banker  insists  upon  a  large  residual  value 
in  the  property  over  the  amount  of  the  bond-issue. 
He  does  not  propose  to  furnish  the  money  to 
construct  his  security.  The  larger  this  margin  of 
value  is,  the  safer  are  the  bonds.  One  measure  of 
equity  is  the  market  value  of  stocks,  based  on 
dividends  paid.  The  banker  is  careful,  however, 
to  determine  whether  these  dividends  have  been 
fully  earned ;  whether  the  market  value  upon  which 
he,  as  the  investor's  representative,  is  asked  to 
rely,  represents  the  judgment  of  the  investor  or  the 
hopes  of  the  speculator. 

A  far  better  guide  to  the  value  of  the  property 
is  the  cost  of  reproduction.  That  a  public-service 
property  has  cost  $5,000,000  is  not  conclusive 
evidence  that  it  can  earn  interest  on  this  sum.  A 
large  part  of  the  money  may  have  been  wasted  by 
careless,  incompetent  engineers,  or  the  plant  may 
be  too  large  for  the  business  to  be  obtained.  As 
a  rule,  however,  the  standard  of  original  cost,  or 
cost  of  replacement,  whichever  is  the  lower,  fur- 
nishes a  safe  guide  to  the  "equity"  or  margin  in 
the  property,  for  the  protection  of  the  bonds. 
With  this  margin  as  a  starting  point,  and  with  the 

160 


THE  PUBLIC-UTILITY  COMPANY 

assurance  of  good  management,  efficient  operation, 
and  the  opportunity  for  the  development  of  a 
large  business,  the  banker  has  only  one  remaining 
consideration  to  examine — the  franchise. 

In  a  preceding  chapter  I  have  shown  that  public- 
service  companies  operating  in  large  cities  were 
so-called  natural  monopolies,  supplying  necessities 
of  life  to  increasing  populations  at  diminishing  costs 
of  production  and  distribution,  at  prices  restricted 
only  by  considerations  of  its  own  interest.  These 
opportunities  for  large  profit  must,  however,  be 
enjoyed  under  the  supervision  of  the  State.  Un- 
reasonable rates  will  not  be  permitted.  The 
evidence  of  unreasonable  rates  is  found  in  an 
imusually  high  percentage  of  earnings.  If  the 
corporation  has  an  express  franchise  contract  with 
the  city,  permitting  it  to  charge  a  certain  price  or 
fare,  it  cannot  be  disturbed,  no  matter  how  great 
may  be  its  profits.  In  the  absence  of  such  a 
stipulation,  the  company's  earnings  may  at  any 
time  be  reduced  to  what  the  courts  consider  a 
reasonable  return,  by  a  change  in  rates,  fares,  or 
prices. 

The  banker  must  look  closely  into  the  franchise 
question.  He  must  consider  first  the  term.  If 
the  franchise  is  for  2  5  years,  then  the  bonds  which 
11  161 


THE  CAREFUL  INVESTOR 

he  buys  should  mature  within  25  years.  The 
banker  next  considers  the  burdens  imposed  by  the 
franchise  upon  the  company,  what  payments —  car 
licenses,  street  repairs,  lighting,  direct  contribu- 
tion to  the  public  treasury — does  it  impose,  and 
finally,  what  are  the  provisions  for  extension  at  the 
expiration  of  the  franchise?  These  questions  are 
the  most  important  asked  by  the  banker  concern- 
ing the  terms  on  which  the  company,  the  purchase 
of  whose  bonds  he  is  considering,  will  be  allowed 
to  do  business  during  the  life  of  the  bonds. 

In  recent  years  a  solution  of  the  franchise  ques- 
tion has  been  attempted  by  the  development  of 
various  plans  of  city  partnership  in  public-service 
imdertakings.  The  experiments  of  Chicago,  Phila- 
delphia and  New  York  in  this  direction  we  have 
now  to  consider. 


XIV 

THE  PUBLIC-SERVICE  CORPORATION 
AND  THE  CITY 

The  last  chapter  outlined  the  examination  which 
is  made  by  the  investment-banker  when  he  is 
asked  to  purchase  the  securities  of  a  public-service 
corporation.  The  conclusion  was  reached  that  the 
most  important  part  of  this  examination  concerns 
the  franchise,  the  right  of  the  company  to  do 
business. 

The  foundation  of  investment  is  legal  security. 
A  corporation  is  created  by  the  State,  and  is  pro- 
tected by  the  power  which  creates  it.  It  is  given 
great  privileges:  the  right  to  do  business  as  a 
private  individual  or  a  partnership;  the  right  to 
take  private  property  at  a  fair  valuation  even 
against  the  'v^^ll  of  its  owners ;  the  right  to  occupy 
the  public  streets  with  tracks,  pipes,  and  wires; 
and  the  right  to  a  fair  return  on  the  money  which 
its  o\\Tiers  have  contributed,  or  which  it  may  have 
borrowed  from  creditors. 

Along  with  these  rights,   however,   go  certain 

obligations,  often  not  clearly  defined  in  charters 

163 


THE  CAREFUL  INVESTOR 

and  franchise  contracts,  but  more  or  less  clearly 
understood  by  all  parties.  These  obligations  are 
to  give  good  service,  to  charge  reasonable  rates, 
to  seek  additional  privileges  only  through  legiti- 
mate channels,  to  recognize  that  a  public  corpora- 
tion has  a  public  duty  to  perform,  and  that  the 
interests  of  the  people  are,  in  a  sense,  placed  in  its 
l:eeping. 

The  case  is  perfectly  plain.  Here  is  an  agree- 
ment to  which  the  public  and  the  public-service 
corporations  are  parties.  The  party  of  the  first 
part  gives  certain  privileges,  special  opportunities 
for  making  money.  The  party  of  the  second  part, 
perhaps  not  expressly,  but  by  plain  implication, 
agrees  to  develop  these  privileges  and  opportunities 
in  such  a  way  as  to  benefit  not  merely  themselves 
but  the  people  from  whom  these  advantages  are 
derived. 

There  is  a  widespread  sentiment,  only  recently 
beginning  to  subside,  that  the  public-service  cor- 
porations have  not  lived  up  to  their  part  of  the 
agreement.  It  is  claimed,  and  generally  believed, 
that  these  valuable  franchise  privileges  have  been 
capitalized  at  excessive  figures,  and  that  unreason- 
able rates  and  prices  have  been  charged  to  pay 
interest  and  dividends  on  this  inflated  capitali- 

164 


THE  CITY 

zation.  As  a  result  of  this  heavy  capitalization, 
which  often  takes  the  form  of  bonds  or  is  repre- 
sented by  leases  at  very  high  figures,  it  is  claimed 
that  the  good  service  which  should  be  rendered 
by  the  public-service  corporation  is  frequently 
allowed  to  deteriorate.  In  other  words,  in  order 
to  pay  interest,  dividends,  and  rentals,  the  public 
is  forced  to  stand  in  the  street-cars,  when  a  more 
moderate  capitalization  would  allow  a  sufBcient 
equipment  to  give  each  rider  a  seat. 

There  was,  no  doubt,  some  ground  for  these 
criticisms,  even  though  the  statements  on  which 
they  were  based  were  in  many  cases  greatly  ex- 
aggerated and  distorted. 

Within  the  last  ten  years  the  public  came  to 
believe  that  they  were  absolved  from  their  implied 
promise  to  allow  the  public-service  corporations  a 
free  hand  in  their  business,  since  the  public-service 
corporations  had  not  kept  their  part  of  the  agree- 
ment. The  aid  of  the  government  was  thereupon 
invoked  to  force  what  the  people  considered  resti- 
tution. Taxes  were  laid  upon  franchises.  The 
price  of  gas  and  telephone  service  was  subjected 
to  sudden  and  drastic  reduction.  Public  senti- 
ment was  invoked  to  refuse  to  extend  franchise 

grants,  and  taxes  on  property  were  largely  in- 

165 


THE  CAREFUL  INVESTOR 

creased.  Restrictions,  as,  for  example,  in  refer- 
ence to  street  cleaning  and  repair,  or  the  placing 
of  wires  underground,  were  imposed.  In  many- 
parts  of  the  country — Chicago,  Cleveland,  St. 
Louis,  Detroit,  Pittsburg,  Philadelphia,  and  New 
York — this  agitation  against  the  public-service 
corporations  broke  out  with  great  violence.  The 
agitation  resulted,  for  a  time,  in  discrediting  the 
securities  of  these  companies.  As  a  result  several 
of  these  corporations  were  forced  into  bankruptcy. 
Others  staggered  along  on  the  brink  of  insolvency. 
It  was  impossible  to  obtain  the  capital  for  neces- 
sary improvements  and  extensions  in  the  face  of 
hostile  public  opinion.  The  investor  would  have 
nothing  to  do  with  securities  which  were  so  badly 
tainted  with  unpopularity. 

The  situation  became  intolerable.  On  the  one 
hand,  the  public  was  suffering  from  the  lack  of  the 
facilities,  particularly  in  the  field  of  transporta- 
tion ;  on  the  other  hand,  companies  could  not  raise 
the  money  to  provide  these  facilities.  The  people 
attacked  the  corporations  for  their  bad  service,  and 
the  corporations  responded,  with  truth,  that  until 
the  attitude  of  the  public  changed  and  these  attacks 
ceased,  bad  service  was  all  that  could  be  furnished. 

A  compromise  was  demanded  in  every  interest. 

166 


THE  CITY 

One  of  the  best  evidences  of  the  essential  sanity 
of  the  American  people  in  their  dealings  with  the 
problems  of  public  business  is  the  manner  in  which 
they  have  worked  out,  to  a  satisfactory  solution, 
the  problems  of  the  relations  between  the  city  and 
the  public-service  corporation.  How  this  has  been 
done  can  best  be  told  by  a  series  of  illustrations. 

The  Chicago  Railways  Company  owns  and  oper- 
ates about  450  miles  of  electric  railway,  serving 
the  downtown  sections  as  well  as  the  entire  north 
and  west  sides  of  the  city  of  Chicago.  This  com- 
pany is  the  successor  of  two  corporations  which 
formerly  operated  these  properties,  and  which,  in 
their  turn,  represented  consolidations  of  smaller 
companies.  All  these  companies  were  greatly 
overcapitalized,  and  the  service  which  they  fur- 
nished was  perhaps  the  worst  in  the  United  States. 

As  a  result  of  negotiations  with  the  city  of 
Chicago,  which  followed  the  refusal  of  the  city  to 
extend  the  franchises  of  the  companies,  an  ordi- 
nance was  passed  dated  February  11,  1907,  and 
approved  by  the  voters,  which  granted  the  Chicago 
Railways  Company  a  twenty-year  franchise. 
Under  this  franchise  ordinance,  the  company  was 
required  to  carr>''  out  a  comprehensive  plan  of 

rebuilding  the  property.      During  the  next  two 

167 


THE  CAREFUL  INVESTOR 

years,  the  company  spent  about  $29,000,000  on 
these  improvements,  and  the  property,  on  Feb- 
ruary I,  191 1,  was  appraised  at  $68,226,612.  The 
city  retains  an  option  to  purchase  all  of  the  prop- 
erties of  the  company  for  municipal  ownership 
and  operation  at  any  time  during  the  life  of  the 
franchise  at  a  price  equal  to  the  valuation  on 
February  i,  1907,  $30,779,875,  plus  all  expendi- 
tures since  February  i,  1907,  for  reconstruction 
and  extensions. 

In  case  the  property  shall  not  be  purchased  be- 
fore the  expiration  of  the  twenty  years  named  in 
the  franchise,  the  city  agrees  that  it  will  not  then 
grant  a  franchise  to  any  other  corporation  for  a 
competing  system  of  street  railways  in  this  com- 
pany's territory,  unless  this  corporation  shall  pur- 
chase the  property  of  the  company  at  the  price 
specified.  The  city  may  require  the  company  to 
sell  this  property  to  some  other  corporation  or  may 
purchase  it  itself  prior  to  1927,  but  in  either  case 
the  price  paid  shall  be  20  per  cent,  above  the 
$30,779,875,  the  original  appraised  value,  plus  the 
cost  of  the  cost  of  all  additions.  The  franchise 
further  provides  for  a  straight  five-cent  fare,  with 
universal  transfer. 

An  important  feature  of  the  agreement  is  the 
168 


THE  CITY 

division  of  the  earnings.  For  the  first  time,  a 
large  American  municipality  asserted  its  right  to 
participate  in  the  profits  of  companies  owning  and 
occupying  its  streets  for  the  purpose  of  profit. 
The  agreement  provides  that  out  of  the  gross 
earnings  of  the  company  there  shall  first  be  paid 
all  taxes  and  fixed  charges  for  maintaining  the  prop- 
erty and  replacing  it,  and  5  per  cent,  upon  the 
value  of  the  properties  as  increased  from  time  to 
time.  What  remains  is  called  surplus  earnings. 
Of  these  earnings,  the  city  is  entitled  to  55  per 
cent,  and  the  company  to  45  per  cent. 

This  contract  has  proven  to  be  profitable  for 
the  city,  and  it  is  expected  that  in  time  it  will  be 
profitable  for  the  company.  For  the  year  191 1- 
12,  the  net  income  from  the  operation  of  these 
lines  was  $1,494,375.  Of  this  amount  the  city  of 
Chicago  received,  as  its  share  in  the  municipal 
enterprise,  $821,906,  and  the  company  received 
$672,469.  The  company  has  excellent  credit,  and 
its  property  has  been  completely  reconstructed, 
all  this  work  being  done  under  the  supervision  of 
a  Board  of  Supervising  Engineers  responsible  to 
the  city.     The  service  is  now  excellent. 

In  spite  of  the  fact  that  the  bonds  of  this  com- 
pany are  issued  under  what  is  known  as  an  open- 

169 


THE  CAREFUL  INVESTOR 

end  mortgage — that  is,  a  mortgage  which  places 
no  limit  upon  the  amount  of  bonds  to  be  issued — 
the  careful  supervision  of  the  expenditure  of  the 
proceeds  of  the  bonds,  and  the  great  security 
which  the  investor  feels  in  the  contract  with  the 
city  of  Chicago,  has  maintained  prices  for  these 
bonds,  which,  when  one  considers  the  large  amount 
issued,  and  the  unsavory  reputation  of  Chicago 
traction  securities  before  the  passage  of  this  ordi- 
nance, must  be  regarded  as  remarkably  high. 

The  settlement  of  the  transit  problem  in  Phila- 
delphia proceeded  along  different  lines,  although 
the  same  underlying  principle  of  partnership  be- 
tween the  city  and  the  company  was  followed. 
The  street-railway  system  of  Philadelphia  had 
been  controlled  since  July  i,  1902,  by  the  Phila- 
delphia Rapid  Transit  Company.  This  company 
succeeded  in  operation  and  control  to  the  Union 
Traction  Company,  which  was  the  successor  of 
three  former  consolidations.  The  method  of  con- 
solidation in  each  case  was  a  lease  of  the  underlying 
companies  to  a  controlling  company  at  a  high  rate. 

These  successive  increases  in  rentals  from  one 
consolidation  to  another  were  paid  without  diffi- 
culty so  long  as  the  street-railway  system  was 
operated  by  surface  lines.     The  population  grew 

170 


THE  CITY 

steadily,  and  the  earnings  rapidly  increased. 
"VMien  the  Rapid  Transit  Company  entered  the 
field,  however,  it  became  necessar>'  to  invest  a 
great  sum  in  an  elevated  and  subway  property, 
to  build  additional  power  plants,  and  to  replace 
a  large  amount  of  track  and  equipment.  The 
Rapid  Transit  Company  spent,  approximately, 
$50,000,000  on  the  system.  In  spite  of  this  enor- 
mous outlay,  however,  the  profits  did  not  increase. 
Many  complaints  were  also  made  of  the  inade- 
quacy of  the  service  furnished  by  the  company. 
It  was  proposed  that  the  city  should  exercise  the 
reserved  right  of  purchasing  the  company's  prop- 
erty, that  franchises  should  be  granted  to  compet- 
ing companies  if  they  would  agree  to  good  service, 
and  that  the  company  should  be  forced  to  place 
its  overhead  wires  in  underground  conduits.  These 
persistent  attacks  upon  the  company  seriously 
injured  its  credit,  and  transportation  develop- 
ment was  at  a  standstill. 

Under  the  inspiration  of  an  association  of  retail 
merchants,  in  1907,  the  year  that  marked  the  con- 
clusion of  the  Chicago  agreement,  the  relations 
between  the  Rapid  Transit  Company  and  the 
city  of  Philadelphia  were  adjusted  by  an  agree- 
ment.   This  agreement  provided  for  a  community 

171 


THE  CAREFUL  INVESTOR 

of  interest  between  the  city  and  the  company.  The 
company  agrees  that  it  will  not  make  any  issues 
of  stocks  or  bonds  without  first  obtaining  the 
approval  of  the  city;  that  if  the  city  shall  at  any 
time  decide  that  new  lines  should  be  built,  it  shall 
notify  the  company  to  build  such  new  lines,  and 
if  the  company  does  not  accept  the  plans  of  the 
city  in  this  respect,  the  city  may  offer  the  right 
to  construct  such  roads  to  any  other  corporation; 
that  the  mayor  and  two  citizens  shall  represent 
the  city  on  the  board;  and  that  the  city  is  to 
share  equally  with  the  company  in  all  dividends 
above  the  return  of  6  per  cent,  to  the  share-holders, 
which,  however,  since  no  dividends  have  been  paid, 
stands  as  an  accumulated  charge  in  favor  of  the 
stock-holders  and  against  the  city;  that  the  com- 
pany relinquishes  its  right  to  build  a  subway 
bisecting  the  city  from  north  to  south,  allowing 
the  city  to  make  any  other  arrangement  which  may 
seem  desirable  for  its  construction;  and  that  the 
company  shall  maintain  a  sinking  fund  which, 
beginning  July  i,  191 2,  shall  amount  to  $120,000 
a  year  for  ten  years,  and  shall  thereafter  increase 
until  $5,000,000  has  been  accumulated,  which  shall 
then  be  paid  into  the  city  treasury,  and  all  future 

sinking  fund  payments  made  to  the  city  treasurer. 

172 


THE  CITY 

In  addition  to  the  sinking-fund  payments,  the 
company,  during  the  first  ten  years,  in  Heu  of  all 
obligations  for  paving,  removal  of  snow,  license 
fees,  etc.,  shall  pay  into  the  city  treasury  the  sum 
of  $500,000,  this  increasing  until,  during  the  last 
ten  years  of  the  agreement,  it  shall  reach  $700,000. 
On  July  I,  1957,  or  on  any  July  i  thereafter,  the 
city  reserves  the  right  to  purchase  all  the  property, 
leaseholds,  and  franchises  of  the  company  for  an 
amount  equal  to  the  par  value  of  its  capital  stock 
outstanding,  at  the  date  of  agreement  $30,000,000, 
plus  any  additional  stock  issued  with  the  consent 
of  the  city.  The  money  paid  into  the  sinking  fund 
is  to  be  available  to  the  city  in  part  purchase  of 
the  property  of  the  company,  should  the  city  elect 
to  exercise  its  option. 

Upon  the  acceptance  by  the  company  of  this 
agreement,  the  city  confirmed  all  of  the  franchises 
and  rights  of  the  company  and  its  subsidiaries, 
many  of  which  had  been  called  into  serious  ques- 
tion, and  provided  that  the  rates  of  fare  then 
obtaining  could  be  changed  only  with  the  consent 
of  both  parties. 

This  agreement  finally  laid  to  rest  all  the  appre- 
hensions of  investors  in  Philadelphia  street-rail- 
way stocks  and  bonds  as  to  the  legal  security  of 

173 


THE  CAREFUL  INVESTOR 

their  investment.  It  made  the  city  and  the  com- 
pany partners  in  their  transportation  system.  It 
gave  the  city  what  will  eventually  be  a  substantial 
interest  in  the  properties  of  the  company.  It 
insured  a  large  measure  of  control  by  the  city 
officials  over  certain  features  of  the  management 
of  the  company.  It  made  provision  for  the  future 
growth  of  the  system  by  the  construction  of  addi- 
tional lines.  It  also  reserved  to  the  city  the  right 
to  acquire  a  property  which  in  1957  will  be  enor- 
mously valuable,  at  a  price  which  is  reasonably 
certain  to  represent  but  a  portion  of  its  value. 

New  York  City  has  gone  still  further  in  the 
harmonizing  of  the  relations  between  the  city 
and  the  public-service  corporation.  New  York 
has  worked  out  a  plan  for  utilizing  the  credit  of 
the  city  in  the  construction  of  subway  lines  for 
which  private  capital  could  not  be  secured  on 
advantageous  terms.  In  the  case  of  the  original 
subway,  the  city  furnished  all  the  money  for  con- 
struction. Large  extensions  of  this  system  are 
now  in  progress,  which  will  be  paid  for  in  part  by 
the  companies  and  in  part  with  public  money. 
The  leases  and  contracts  under  which  the  city 
furnishes  this  money  are  made  on  terms  which 

provide  for  the  payment  of  interest  on  the  city 

174 


THE  CITY 

bonds  issued  to  provide  these  funds,  plus  a  sinking 
fund.  The  right  of  purchase  at  the  end  of  a  term 
of  years  is  reserved.  They  represent  the  furthest 
development  in  the  cooperation  between  the  city 
and  the  municipality. 

The  rights  of  the  public  either  to  own  their 
transportation  system  or  to  retain  the  reserved 
interest,  and,  in  the  meantime,  to  share  in  the 
profits;  to  supervise,  in  so  far  as  is  necessary  to 
secure  good  service,  construction  and  operation; 
and  to  regulate  the  capitalization  to  prevent 
inflation,  are  now  established.  In  return,  the 
public  has  come  to  recognize  its  obligation  to  pro- 
tect the  companies  in  the  enjoyment  of  liberal 
franchise  privileges  for  a  fixed  term  of  years,  to 
secure  adequate  compensation  for  all  their  outlay 
of  capital ;  and,  at  the  end  of  the  franchise  period, 
in  case  it  is  not  deemed  wise  to  extend  these  privi- 
leges, to  pay  to  the  company  a  fair  compensation 
for  the  property.  Finally,  if  New  York  is  to  be 
taken  as  the  most  advanced  type  of  municipal 
cooperation  with  public-service  corporations  it  is 
now  recognized  as  a  proper  function  of  municipal 
government,  to  provide,  by  the  use  of  the  public 
credit,  for  the  construction  of  subway  lines,  which 

are  then  to  be  turned  over  for  operation  to  private 

175 


THE  CAREFUL  INVESTOR 

corporations.  The  public-service  corporations,  in 
their  turn,  have  not  only  recognized  the  right  of 
the  people  to  ownership  and  control,  but  also  to 
share  in  the  profits  of  operation. 

Ten  years  ago  there  was  much  talk  of  municipal 
ownership  and  operation  of  public  utilities  as  the 
only  escape  from  a  situation  which,  all  agreed, 
was  fast  becoming  intolerable.  To-day,  while 
municipal  ownership,  actual  or  reserved,  is  now 
accepted  without  question,  the  talk  of  municipal 
operation  has  entirely  disappeared.  The  American 
city  and  the  public-service  corporation  have  en- 
tered into  a  partnership  for  mutual  advantage. 
As  a  result  of  this  partnership,  the  position  of 
public-service  corporations  before  the  public  and 
with  the  investor  has  been  much  improved. 


XV 

THE  PUBLIC-SERVICE  COMMISSION  AND 
THE  INVESTORS 

We  have  examined  the  methods  employed  by  the 
investment-banker  in  investigating  the  securities 
of  public-service  corporations.  We  saw  with  what 
great  care  these  investigations  are  made,  and  with 
what  searching  scrutiny  every  factor  bearing  upon 
the  merits  of  the  enterprise  is  considered.  As 
a  result  of  these  careful  examinations,  the  number 
of  failures  among  public-utility  corporations  is 
each  year  diminishing,  and  the  investor  can  buy 
these  securities  with  confidence. 

Supplementing  the  work  of  the  investment- 
banker,  although  undertaken  with  a  different 
motive,  many  States  have  established  administra- 
tive bodies  known  as  Public-Service  Commissions, 
who  are  charged  with  the  duty  of  supervising  the 
rates  and  prices,  the  service,  and,  incidentally,  the 
capitalization,  accounting  methods,  and  financial 
policy  of  public-service  corporations.    The  primary 

'  Note. — This  chapter  is  substantially  identical  with  Chapter 
VI  in  the  author's  Corporation  Finance. 
12  177 


THE  CAREFUL  INVESTOR 

object  in  the  establishment  of  these  commissions 
has  been  to  protect  the  public  against  bad  service 
and  excessive  rates  and  prices. 

In  order  to  make  sure  that  corporations  subject 
to  their  jurisdiction  are  honestly  capitalized,  so 
that  they  may  not  have  any  inducement  unduly 
to  advance  rates  in  order  to  pay  interest  and  divi- 
dends on  capitalization  representing  no  actual 
value,  and  in  order  that  the  proceeds  of  their  sales 
of  stock  and  bonds  should  be  applied  to  the  im- 
provement of  their  plant  and  to  the  consequent 
betterment  of  their  service,  some  of  the  Public- 
service  Commission  laws  clothe  the  commissions 
with  authority  over  the  issue  of  securities. 

The  nature  of  this  power  over  security  issues  is 
indicated  by  the  following  extract  from  the  Act 
Creating  the  Public-Service  Commissions  of  New 
York: 

Any  common  carrier,  railroad  corporation  or  street  railroad 
corporation  organized  under  the  laws  of  the  State  of  New  York, 
may  issue  bonds,  stocks,  notes  or  other  evidences  of  indebtedness 
payable  at  periods  of  more  than  twelve  months  after  the  date 
thereof,  when  necessary  for  the  acquisition  of  property,  the  con- 
struction, completion,  extension  or  improvement  of  its  facilities, 
or  for  the  improvement  or  maintenance  of  its  service  or  for  the 
discharge  or  lawful  refunding  of  its  obligations,  provided  and 
not  otherwise  that  there  shall  have  been  secured  from  the  proper 
conimission  an  order  authorizing  such  issue,  and  the  amount 
thereof  and  stating  that,  in  the  opinion  of  the  commission,  the 

178 


THE  INVESTOR 

use  of  the  capital  to  be  secured  by  the  issue  of  such  stock,  bonds, 
notes,  or  other  evidences  of  indebtedness  is  reasonably  required 
for  the  said  purpose  of  the  corporation.  For  the  purpose  of 
enabling  it  to  determine  whether  it  should  issue  such  an  order, 
the  commission  shall  make  such  inquiry  or  investigation,  hold 
such  hearings  and  examine  such  witnesses,  books,  papers,  docu- 
ments or  contracts  as  it  may  deem  of  importance  in  enabling 
it  to  reach  a  determinatioa. 

Under  this  power,  every  corporation  proposing  to 
issue  or  authorize  any  securities  must  apply  to  the 
Public-Service  Commission  for  authorization,  and 
the  new  securities  will  not  be  sanctioned  unless 
the  Commission  is  first  satisfied  that  the  issue  is 
for  the  best  interests  of  the  company.  The  method 
of  procedure  in  cases  involving  the  authorization 
of  bond-issues  is  outlined  by  the  Commission  of 
the  Second  District  of  New  York  in  its  second 
annual  report,  as  follows : 

In  passing  upon  the  application  for  leave  to  issue  additional 
capital  stock,  the  Commission  will  consider: 

Whether  there  is  reasonable  prospect  of  fair  return  upon  the 
investment  proposed,  to  the  end  that  securities  having  apparent 
worth  but  actually  little  or  no  value  may  not  be  issued  with  our 
sanction. 

We  think  that  to  a  reasonable  e.xtent  the  interests  of  the 
investing  public  should  be  considered  by  us  in  passing  upon  these 
applications. 

The  Commission  should  satisfy  itself  that,  in  a  general  way, 
the  venture  will  be  likely  to  prove  commercially  feasible,  but  it 
should  not  undertake  to  reach  and  announce  a  definite  conclusion 
that  the  new  construction  or  improvement  actually  constituted 

179 


THE  CAREFUL  INVESTOR 

a  safe  or  attractive  basis  for  investment.  Commercial  enterprises 
depend  for  their  success  upon  so  many  conditions  which  cannot 
be  foreseen  or  reckoned  with  in  advance,  that  the  duty  of  the 
Commission  is  discharged  as  to  appHcations  of  this  character 
when  it  has  satisfied  itself  that  the  contemplated  purpose  is  a 
fair  business  proposition. 

Although  the  Commission  here  expressly  dis- 
affirms its  intention  to  guarantee  the  securities 
whose  issues  it  sanctions,  yet  its  method  of  pro- 
cedure is  so  careful  as  actually  to  reach  this  result. 
This  method  is  as  follows : 

An  estimate  will  be  made  from  a  consideration  of  the  results 
of  operation  of  existing  roads  of  the  probable  gross  earnings. 

An  estimate  will  be  made  in  like  manner  of  the  probable  oper- 
ating expenses,  taxes,  and  depreciation  charges. 

The  excess  of  earnings  over  the  disbursements  which  must  be 
made  before  fixed  charges  can  be  met  represents  the  sum  which 
is  applicable  to  fixed  charges. 

The  maximum  bond  issue  which  will  be  allowed  must  be 
determined  by  the  sum  thus  ascertained  to  be  applicable  to  the 
payment  of  the  interest  charge. 

No  bond  issue  should  be  permitted  creating  an  interest  charge 
beyond  an  amount  which  it  is  reasonably  certain  can  be  met  from 
the  net  earnings. 

Stock  representing  a  cash  investment  should  be  required  to  an 
amount  sufficient  to  afford  a  moral  guarantee  that,  in  the  judg- 
ment of  those  investing,  the  enterprise  is  likely  to  prove  commer- 
cially successful. 

The  order  authorizing  such  stock  and  bond  issues  will  contain 
approximate  provisions  designed  to  secure  the  construction  of 
the  road  in  accordance  with  the  plans  and  specifications  upon 
which  the  authorization  was  made  and  not  in  excess  of  the  actual 
requirements. 

180 


THE  INVESTOR 

If  the  allowance  proves  inadequate  for  the  required  purposes, 
an  application  for  further  capitalization  may  be  made,  upon 
which  application  the  expenditure  of  the  proceeds  of  stock  and 
bonds  already  authorized  must  be  shown  in  detail. 

After  an  issue  of  bonds  has  passed  successfully- 
through  the  ordeal  of  this  investigation,  the  inves- 
tor need  have  little  fear  concerning  their  safety. 

There  is  another  aspect  of  the  Public-Service 
Commission  matter  which  is  even  more  reassuring 
to  the  investor.  When  a  Public-Service  Commis- 
sion has  authorized  the  issue  of  securities,  it  is,  by 
implication,  bound  to  protect  the  company  whose 
application  it  has  authorized,  not  merely  against 
the  action  of  their  directors  in  borrowing  money 
or  issuing  stock  against  the  best  interests  of  the 
corporation,  but  also  to  protect  them  against 
competing  enterprises  for  which  there  is  no  public 
necessity,  and  which  would  not,  therefore,  prove 
profitable.  The  best  recent  example  of  the  pro- 
tection which  the  Public-Service  Commission  gives 
a  company  whose  capitalization  and  rates  are 
subject  to  its  jurisdiction,  is  in  the  refusal  of  the 
application  of  the  Buffalo,  Rochesteir  and  Eastern 
Railroad  for  authority  to  issue  securities  for  the 
construction  of  a  line  of  railroad  from  Buffalo  to 
Albany  which  was  to  parallel  the  line  of  the  New 

181 


THE  CAREFUL  INVESTOR 

York  Central.  The  ground  of  the  refusal  was  that 
there  was  no  necessity  for  the  new  line,  that  it 
would  not  prove  profitable,  that  it  would  injure  the 
New  York  Central,  and  that  no  public  benefit  would 
result.  A  summary  of  the  conclusions  of  the  Com- 
mission upon  these  various  matters  is  as  follows : 

First,  that  the  cost  of  the  proposed  road  would 
be  about  $100,000,000. 

Second,  that  existing  railroad  facilities  between 
Buffalo  and  the  Hudson  River  were  adequate  to 
take  care  of  existing  business  and  for  a  very  large 
increase  in  future  traffic. 

Third,  that  the  cost  of  the  proposed  road  would 
require  a  capitalization  of  $336,700  per  mile,  much 
larger  than  the  capitalization  of  any  railroad  sys- 
tem in  the  country. 

Fourth,  that  this  capitalization  would  require 
earnings  per  mile  of  at  least  $48,100,  if  5  per  cent, 
was  to  be  earned  on  the  amount  invested. 

Fifth,  that  to  earn  this  sum  would  involve  a 
traffic  greatly  in  excess  of  the  traffic  of  any  rail- 
road in  the  country. 

Sixth,  that  the  proposed  road  would  not  be  able 

to  forward  its  freight  over  its  eastern  connections 

at  the  Hudson  River,   since  these  were  already 

over- taxed. 

182 


THE  INVESTOR 

Seventh,  that  the  proposed  road  did  not  con- 
template any  benefit  to  the  public  in  the  reduction 
of  rates,  and,  finally,  that  the  applicant  had  not 
shown  sufficient  financial  ability  to  justify  issuing 
to  it  a  certificate  of  public  convenience  and  neces- 
sity to  construct  a  road  costing  $100,000,000. 

If  the  Public  Service  Commission  of  New  York 
had  been  in  existence  thirty  years  ago,  the  unneces- 
sar>%  costly,  and  wasteful  West  Shore  and  Nickel 
Plate  Railroads,  which  were  constructed  for  no 
other  purpose  than  to  divide  traffic  which  the 
New  York  Central  and  the  Lake  Shore  and  Michi- 
gan Southern  were  handling  with  economy  and 
despatch,  would  not  have  been  authorized,  and  a 
large  amount  of  the  reckless  railroad  construction 
west  of  the  Mississippi,  which  bankrupted  the 
Atchison,  Topeka  and  Santa  Fe,  the  St.  Louis 
and  San  Francisco,  and  assisted  in  breaking  down 
the  Northern  Pacific,  would  not  have  been  sanc- 
tioned. 

The  Public-Service  Commission  not  only  pro- 
tects the  investor  against  the  inevitable  conse- 
quences of  competition  where  no  necessity  for  the 
competing  property  exists,  but  it  also  secures  his 
company  in  the  right  to  charge  such  rates  and 

fares  as  will  yield  a  reasonable  return  on  secxirities. 

183 


THE  CAREFUL  INVESTOR 

At  the  time  the  New  York  PubHc-Service  Com- 
missions were  instituted,  the  most  serious  apprehen- 
sions were  expressed  by  financial  interests  that  the 
new  laws  which  took  from  directors  and  stockhold- 
ers most  of  the  control  which  they  had  previously 
exercised  over  the  issues  of  new  securities  would 
seriously  interfere  with  the  efforts  of  companies  to 
provide  new  capital.  As  the  Commissions  have 
progressed,  however,  since  they  have  been  forced 
into  the  position  of  virtually  guaranteeing  every 
issue  which  they  approve  on  the  basis  of  a  careful 
investigation  of  the  prospects  of  the  enterprise,  a 
critical  examination  of  its  engineering  features,  the 
rock  on  which  so  many  new  schemes  are  wrecked, 
and  an  assurance  to  the  investor  that  reasonable 
rates  will  be  allowed  and  that  cut-throat  competi- 
tion will  be  prevented,  they  have  come  to  be  very 
favorably  regarded  by  investment  bankers. 

The  bond-salesman  who  can  offer  a  security 
whose  issue  has  been  approved  by  some  public- 
service  commission  has  his  work  of  persuasion 
largely  accomplished.  Indeed,  the  sentiment 
among  investment-bankers  is  nearly  unanimous 
as  to  the  benefits  which  have  come  to  their  business 
from  the  work  of  these  regulative  bodies. 


184 


XVI 
FARM  MORTGAGES 

A  FARM  mortgage  does  not  differ  from  any  other 
mortgage.  It  is  a  promise  to  pay  one,  two,  five, 
or  ten  thousand  dollars  in  three  or  five  years  from 
date,  and  it  is  secured  by  the  mortgage  which 
conveys,  in  trust,  to  the  lender  the  title  to  the 
mortgaged  property.  This  conveyance  is  recorded 
in  the  county  in  which  the  property  is  located, 
thus  establishing  the  claim  of  the  lender  as  a  first 
lien  upon  the  mortgaged  premises.  The  advan- 
tages and  disadvantages  of  this  form  of  mortgage, 
as  compared  with  an  investment  in  the  bonds  of 
a  large  corporation,  may  be  summarized  as  follows : 

The  first  advantage  of  the  farm  mortgage  is  its 
high  yield.  The  Central  West,  the  part  of  the 
country  in  which  mortgage  loans  are  preferably 
made  by  conservative  investors,  is  now  making 
loans  on  a  6  per  cent,  basis  to  the  investor.  The 
Western  States,  as  a  rule,  do  not  tax  at  home 
investments  in  foreign  loans,  and  this  gives  the 
investor  the  opportunity  to  realize  the  full  interest 
return. 

185 


THE  CAREFUL  INVESTOR 

The  second  advantage  of  the  farm  loan  is  its 
early  maturity.  The  purchaser  of  a  bond  of  a 
railway  company  cannot  get  his  money  back  from 
the  company  for,  perhaps,  thirty  or  even  fifty 
years.  His  only  way  of  recovering  his  principal 
is  to  sell  his  bond  to  some  other  investor.  This 
involves  the  risk  of  depreciation  in  the  principal. 
The  investor  may  have  purchased  his  bond  for 
105,  and  when  he  comes  to  sell,  it  may  have  de- 
clined to  99K.  owing  to  a  falling-off  in  the  demand 
for  securities  of  that  character.  The  bond  is  still 
perfectly  good,  his  interest  will  be  paid  regularly, 
but  he  has  sustained  a  loss  on  the  capital  value  of 
his  investment.  The  investor  in  a  farm  m^ortgage, 
however,  can  get  his  money  back  from  the  bor- 
rower at  the  end  of  three  or  five  years. 

The  third  point  in  favor  of  the  farm  mortgage 
is  closely  connected  with  that  just  mentioned, 
namely,  the  greater  control  which  the  investor  has 
over  his  investment.  Provision  is  usually  made  in 
the  mortgage  for  an  indefinite  extension  from  year 
to  year  at  the  expiration  of  the  term  named  in  the 
instnmient.  When  this  provision  is  included,  if 
the  investor  wishes  the  return  of  his  principal  at 
the  end  of  the  term,  he  can  have  it.  If  he  wishes 
a  longer-term  investment,  he  can  allow  the  mort- 

186 


FARM  MORTGAGES 

gage  to  run  from  year  to  year.  A  good  farmer 
can  make  more  than  6  per  cent,  by  investing 
money  in  buildings  and  improvements  and  in  land, 
and  often  is  not  anxious  to  pay  off  his  mortgage. 
At  the  end  of  any  year,  however,  the  mortgage 
can  be  called  up  and  the  investor  can  get  his 
money. 

All  mortgages,  moreover,  whether  issued  by  a 
great  railway  company  or  by  a  small  farmer  in  North 
Dakota,  provide  that  the  borrower  should  keep 
his  farm,  which  is  the  lender's  security,  in  good 
condition  and  the  buildings  in  good  repair.  It  is 
almost  impossible  for  the  investor  in  a  corporation 
bond  to  enforce  these  provisions.  He  is  only  one 
of  perhaps  2,000  bond-holders;  he  is  represented 
by  a  trustee,  and  he  must  rely  upon  the  trustee 
to  enforce  the  terms  of  the  mortgage.  It  is  not 
the  custom  for  the  trustee,  whatever  powers  may 
be  given  him  by  the  mortgage  instrument,  to 
interfere  with  the  management  of  the  company. 
Instances  have  occurred  where  the  security  of 
mortgage  bonds  has  been  seriously  impaired  be- 
cause of  long-continued  neglect  of  the  property. 
This  is  not  possible  with  the  farm  mortgage,  or 
with  any  other  form  of  real-estate  obligation, 
where  the  security  of  each  loan  is  a  single  piece  of 

1S7 


THE  CAREFUL  INVESTOR 

property,  and  where  the  investor  has  the  oppor- 
tunity of  inspection. 

Against  these  advantages  of  farm-mortgage 
loans,  certain  disadvantages  are  urged.  Some  of 
these  disadvantages  are  inherent  in  this  form  of 
obligation;  others  can  be  overcome  by  employing 
the  services  of  reputable  mortgage-brokers.  The 
first  point  urged  against  the  farm  mortgage  is  its 
short  duration.  At  the  end  of  a  few  years,  the 
lender  may  have  his  money  handed  back  to  him, 
and  be  obliged  to  look  for  a  new  investment.  In 
practice,  however,  this  objection  is  not  serious. 
Either  the  mortgage  is  allowed  to  run  from  year 
to  year,  or  a  new  investment  of  equal  security  can 
be  obtained  without  difficulty. 

Then,  too,  it  is  urged  against  the  farm  mortgage, 
that  the  application  of  the  proceeds  of  the  mort- 
gage to  productive  purposes  is  not  safeguarded  as 
it  is  in  a  bond  executed  by  a  corporation.  When  a 
railroad  company,  for  example,  puts  out  an  issue 
of  bonds  whose  proceeds  are  to  cover  the  construc- 
tion of  a  branch  line,  the  bonds  will  not  be  issued 
by  the  trustee  to  the  banking  house  except  upon 
the  certificate  of  the  company's  engineer  that  a 
certain  amount  of  mileage  has  been  constructed. 

Not  until  the  whole  improvement  has  been  com- 

188 


FARM  MORTGAGES 

pleted,  will  the  entire  number  of  bonds  be  issued. 
In  corporation  mortgages,  the  attempt  is  always 
made  to  provide  for  the  productive  expenditure  of 
the  proceeds  of  the  bonds.  "Spendthrift  bor- 
ro\\ang"  is  not  possible. 

With  farm  mortgages  this  safeguard  is  not 
usually  provided.  The  security  is  stated,  but  the 
purposes  to  which  the  money  is  to  be  applied  are 
not  given.  In  a  number  of  applications  for  farm 
loans  which  I  have  before  me,  no  questions  are 
asked  concerning  the  use  which  the  borrower  will 
make  of  these  funds,  nor  is  any  attempt  made  to 
condition  the  payment  of  the  money  upon  the 
certificate  of  some  third  party  that  a  certain  invest- 
ment of  the  money  is  assured.  This  information 
can  usually  be  obtained  by  the  investor,  how^ever, 
either  through  the  broker  or,  if  he  lends  the  money 
in  person,  from  the  borrower.  There  is  no  reason 
why  farm-mortgage  loans  should  not  be  strength- 
ened by  providing  this  very  important  safeguard. 

The  objection  is  often  made  to  farm  mortgages 

that  they  are  not  available  for  either  quick  sale 

or  as  collateral.     This  objection  is,  in  the  main, 

well  founded.     Farm  mortgages  share  this  defect, 

however,    with    many    unlisted    bonds.     Bonds 

secured  by  first  mortgage  on  a  property  of  a  small 

189 


THE  CAREFUL  INVESTOR 

gas  company,  for  example,  have  a  very  slow  and 
uncertain  market,  and  are  only  available  for  col- 
lateral at  institutions  where  the  property  and  the 
borrower  are  well  known.  If  the  investor  in  Massa- 
chusetts buys  a  farm  mortgage  secured  on  lands 
in  North  Dakota,  his  only  method  of  selling  the 
mortgage  is  to  place  it  through  a  broker,  who  will 
charge  him  a  commission  for  selling  it.  He  can 
also  use  it  as  collateral  about  as  well  as  he  could 
use  an  unlisted  bond  at  a  bank  or  trust  company 
where  his  character  and  standing  are  well  kno-unn, 
but  whose  officers  are  not  familiar  with  the  value 
of  the  property  securing  the  bonds. 

The  availability  of  farm  mortgages  as  collateral 
is  also  restricted  by  the  prohibition  in  the  national 
banking  law  against  lending  on  real-estate  mort- 
gages. This  prohibition  does  not  apply,  however, 
to  loans  by  many  other  financial  institutions. 

It  must  be  admitted  that  the  farm  mortgage 

has  a  slower  market  than  the  corporation  bond, 

although  it  can  be  sold  through  the  same  channels 

as  those  through  which  it  was  purchased.  It  is 

also  not  easy  to  borrow  upon  farm  mortgages. 

These   objections,   however,    apply   only   to   the 

mortgage  as  a  business  man's  investment.    To  the 

investor  who  is  looking  for  a  safe  place  for  his 

190 


FARM  MORTGAGES 

money,  who  does  not  expect  to  sell,  and  who  does 
not  need  to  borrow,  this  argument  against  the 
farm  mortgage  does  not  apply.  There  is,  finally, 
the  objection  to  the  Western  farm  mortgage  from 
the  standpoint  of  the  Eastern  investor,  that  the 
lender  is  sending  his  money  often  2,000  miles 
away,  lending  it  to  a  man  whom  he  has  never  seen, 
on  the  security  of  property  which  he  will  never 
view,  and  taking  a  variety  of  risks  and  hazards, 
for  example,  of  drought,  sickness,  etc.,  from  which 
an  investment  in  corporation  or  municipal  bonds 
is  entirely  free. 

It  is  this  situation  which  calls  the  mortgage- 
broker  into  existence.  Without  his  intervention, 
it  would  be  impossible  for  the  eastern  investor  to 
put  his  money  into  Western  farm  mortgages.  The 
experienced  and  reHable  mortgage-broker,  how- 
ever, who  is  merely  an  investment-banker  in  a 
specialized  field,  is  able  to  remove  these  objections 
to  mortgage  loans. 

An  outline  of  the  service  which  the  broker  per- 
forms for  the  investor  will  show  how  indispensable 
this  service  is.  I  take  this  description  from  a  book- 
let issued  by  a  mortgage  company  doing  business 
in  a  Northwestern  State,  and  which  has  been  in 
business  for  34  years,  with  whose  standing  I  am 

191 


THE  CAREFUL  INVESTOR 

personally  acquainted,  and  for  the  accuracy  of 
whose  statements  I  can  vouch.  The  amount  of 
loans  offered  for  investment  by  this  company  are 
usually  from  30  to  40  per  cent,  of  the  actual  market 
value  of  the  loan.  The  term  of  the  loan  is  five 
years.  When  desired  by  the  borrower,  the  privi- 
lege is  extended  of  repayment  of  part  of  the  loan 
with  interest  date.  Such  repayment  increases  the 
margin  of  security  in  the  property,  and  the  money 
can  be  reinvested  in  other  mortgages  if  desired. 
The  average  size  of  the  loan  is  about  $2,000. 
These  loans  are  made  by  the  company  with  its 
own  money  after  personal  examinations  of  the 
property. 

The  method  of  making  farm  loans  is  as  follows : 
The  farmer  wishes  to  borrow  money  for  additional 
buildings,  for  the  purchase  of  live  stock,  or  for 
payment  for  land.  He  makes  application  to  the 
company  for  a  loan  secured  on  his  land.  His  appli- 
cation furnishes  complete  information  about  his 
land,  his  equipment,  buildings,  live  stock,  and 
machinery,  as  well  as  personal  information  about 
himself,  his  farm,  his  neighbors,  and  general 
neighborhood  conditions  in  his  locality. 

Of  special  interest  in  this  connection  is  the 
detailed  information  which  is  obtained  concerning 

192 


FARM  MORTGAGES 

the  borrower.     Some  of  these  questions  are  ex- 
tremely personal.     The  following  is  a  specimen  list : 

1 .  Full  name  and  age  of  borrower. 

2.  Married  or  single. 

3.  Full  name  and  age  of  wife. 

4.  If  formerly  married,  state  wife's  full  name  and  whether 

divorced  or  deceased. 

5.  If  deceased,  state  whether  she  left  a  will,  and  if  so  when 

and  where  the  same  is  probated. 

6.  If  divorced,  state  where  the  decree  is  filed. 

7.  State  name,  sex,  ages,  and  residences  of  children  by  di- 

vorced wife. 

8.  Have  you  any  who  are  dependent  upon  you  aside  from 

your  own  family? 

9.  What  is  the  general  physical  condition  of  your  family? 

10.  Give  name,  sex,  and  age  of  your  children. 

11.  What  ones  live  at  home  with  you? 

12.  Husband  bom  where? 

13.  Wife  bom  where? 

14.  Belong  to  church? 

15.  Belong  to  fraternal  societies? 

16.  PoHtics? 

17.  Do  you  drink,  and  if  so  to  what  extent? 

The  purpose  of  obtaining  this  detailed  informa- 
tion is  both  for  the  sake  of  security  and  that  the 
prospective  investor  may  have  an  accurate  knowl- 
edge of  the  character  of  the  man  to  whom  he  is 
lending  his  money.  It  also  assists  the  attorneys 
for  the  mortgage  company  in  searching  the  title. 

From  this  information,  the  loan  committee  of 
the  company  passes  judgment  on  the  loan  applied 

13  193 


THE  CAREFUL  INVESTOR 

for.  If  it  is  approved,  the  information  is,  as  far 
as  possible,  verified  on  the  ground  by  their  own 
examiner.  The  title  to  the  property  is  then  ex- 
amined by  their  attorneys.  If  found  perfect, 
papers  for  signature  and  amount  agreed  upon  as 
a  safe  loan  are  sent  to  their  agent  for  the  final 
settlement,  and  the  mortgage  is  recorded  at  the 
county  seat.  The  complete  papers  are  then  as- 
sembled and,  after  proper  record  is  made,  are  given 
a  mortgage  number  and  become  a  part  of  the 
investment.  The  papers  in  a  mortgage  envelope 
consist  of  note  and  mortgage,  assignment  of 
mortgage,  abstract  of  title,  insurance  policy,  if 
any,  application  and  examiner's  report.  The 
mortgage  company  guarantees  each  title. 

The  mortgage  company  not  only  makes  a  careful 
investigation  of  the  quaHty  of  the  mortgage,  but 
during  the  period  of  investigation  it  assumes  the 
entire  management  of  the  loan.  A  record  is  kept 
which  enables  the  company  to  ascertain  whether 
the  farmer's  taxes  and  insurance  premiums  are 
promptly  paid,  and  to  collect  his  interest,  as  well 
as  the  principal  sum,  when  due.  This  provision  is 
made  without  expense  to  the  owner  of  the  mort- 
gage, and  the  company's  profit,  moreover,  is  paid 

by  the  borrower. 

194 


FARM  MORTGAGES 

Two  illustrations  of  the  mortgages  offered  by 
this  concern  will  show  the  quality  of  the  security 
which  is  furnished.    The  names  are  fictitious: 

JAMES  W.  BROWN 

$2,000  County,  North  Dakota. 

This  mortgage  is  dated  December  1,1910,  and  is  due  December 
1, 1915.  The  loan  is  secured  upon  N.  E.  ^  30-133-62,  140  acres 
under  cultivation  and  20  acres  fenced  to  pasture.  It  is  otherwise 
improved  by  a  set  of  buildings  costing  $1,200  or  $1,300,  carrying 
insurance  for  $800,  The  borrower  has  stock  and  machinery  suffi- 
cient to  run  his  farm,  and  is  worth  about  $3,000  all  clear  of  en- 
ctunbrances.  The  soil  is  a  rich,  heavy  black  loam,  with  clay 
sub-soil.    This  quarter,  I  think,  would  readily  sell  at  $45  or  $50 

an  acre.    The  land  is  situated  about  5^3  miles  from , 

and  the  loan  is  being  made  to  pay  a  loan  now  on  the  land. 


C.  F.  EVERHARDT 

$4,500  County. 

This  mortgage  is  secured  upon  280  acres  of  land  about  five 

miles  north  and  west  from  .     The  borrower  is  a 

German,  and  has  resided  here  more  than  twenty  years.  160 
acres  of  the  land  are  now  under  cultivation  and  the  balance 
fenced  to  pasture.  It  is  otherwise  improved  by  buildings  costing 
$2,500.  I  do  not  beheve  that  the  land  could  be  bought  for  less 
than  $50  an  acre.  It  is  a  loan  that  I  can  recommend  in  the 
highest  terms. 

Loans  made  on  this  character  of  security  are  not 
open  to  question.  When  the  broker  is  reliable — 
and  the  investor  can  usually  ascertain  this  fact 
through  his  local  bank — so  that  his  statements  can 

195 


THE  CAREFUL  INVESTOR 

be  relied  upon,  an  investment  in  a  farm  mortgage 
is  as  safe  as  an  investment  in  any  other  fonn  of 
security.  The  farm-mortgage  investor  has  the 
advantage  of  a  high-interest  rate,  and,  if  this  is 
an  object  to  him,  an  early  maturity  of  his  loan. 
Against  this  higher  rate  must  be  balanced  the 
slower  market  and  the  greater  difficulty  in  bor- 
rowing on  the  mortgage,  as  compared  with  a  mort- 
gage bond  of  first  quality. 


XVII 

THE  MORTGAGE  BANK 

Productive  land  furnishes  the  ultimate  security 
for  the  investor.  Outside  of  the  mining  industry, 
which  contributes  but  little  to  the  supply  of  invest- 
ment securities,  all  other  forms  of  investment  rest 
directly  or  indirectly  upon  the  farms.  Railway 
traffic  mainly  comes  from  the  farms.  The  farms 
furnish  most  of  the  raw  material  of  manufacture. 
As  yet,  however,  there  has  been  little  realization 
of  the  farms  themselves  as  a  basis  of  investment. 
The  railroads  of  the  United  States  are  worth,  in 
round  numbers,  $20,000,000,000.  This  entire 
value  is  outstanding  in  the  hands  of  the  investors 
in  the  form  of  stocks  and  bonds.  The  amount  of 
securities  issued  by  industrial  corporations  is 
probably  greater  than  the  value  of  the  property 
which  these  companies  own.  Public-service  cor- 
porations are  fully  represented  by  investment 
securities.  It  is  only  in  the  field  of  real  estate, 
however,  and  particularly  farm  real  estate,  that 
investments  still  lag  far  behind  value. 

According  to  the  census,  there  are  in  the  United 
197 


THE  CAREFUL  INVESTOR 

States  6,361,502  farms,  containing  a  total  of 
878,798,000  acres.  The  total  value  of  this  farm 
property  is  estimated  at  $40,991,000,000,  of  which 
over  two-thirds  represents  the  value  of  the  land, 
one-sixth  the  value  of  the  buildings,  and  one-sixth 
the  combined  value  of  the  improvements,  machin- 
ery, and  live  stock.  The  total  value  of  this  farm 
property  has  more  than  doubled  during  the  decade 
1900  to  1 910.  The  increase  in  farm  land  alone  has 
been  1 1 8.  i  per  cent.  The  average  value  per  acre  of 
the  American  farm  increased  from  $15.57  in  1900, 
to  $3  2 .  40  in  1 9 1  o .  The  explanation  of  this  phenom- 
enal increase  in  land  values  is  found  in  the  fact  that 
while  the  total  population  increased  21  per  cent, 
since  1900,  the  urban  population  increased  34.8  per 
cent,  and  the  rural  population  only  11.2  per  cent. 
The  number  and  acreage  of  farms  increased  much 
less  rapidly  than  the  total  population.  The  value 
of  farm  products,  as  a  consequence  of  this  steadily 
growing  demand  from  cities  and  towns  for  food 
supply,  has  been  rapidly  advancing,  and  has  made 
agriculture  easily  a  most  profitable  business. 

This  great  industry,  however,  is  but  little  known 
to  the  investor.  The  savings  banks  and  insurance 
companies,  and,  to  a  less  extent,  the  commercial 
banks   and   trust   companies,   have   realized   the 

198 


THE  MORTGAGE  BANK 

value  of  the  perfect  security  which  the  farm  mort- 
gage offers,  but  to  the  individual  investor  in  the 
East  these  advantages  are  almost  unknown. 

It  is  unfortunate  for  the  United  States  that  this 
is  the  case.  The  great  problem  before  the  Ameri- 
can people  to-day  is  the  rising  cost  of  living.  How- 
ever economists  may  wrangle  about  the  ultimate 
underiying  cause  of  the  advance  of  the  price  of 
bread  and  meat,  the  plain  explanation  of  this  fact 
is  that  there  is  too  little  bread  and  too  little  meat. 
The  only  cure  for  the  high  prices  of  food  is  to 
produce  more  food.  The  production  of  food  is 
largely  a  matter  of  the  investment  of  capital.  The 
time  of  free  land  with  soil  six  feet  deep,  which 
would  produce  20  crops  of  grain  in  succession 
without  fertilizer,  is  past.  An  extension  of  the 
farms  in  the  United  States  to-day  means  costly 
improvement  in  drainage  and  irrigation,  large 
expenditures  on  improved  farm  buildings,  farm 
machinery,  fertilizer,  and  improved  live  stock. 

The  total  area  of  lands  in  the  United  States 
which  are  to  be  reclaimed  in  whole  or  in  part  by 
drainage  is  estimated  at  225,000,000  acres.  Of 
this  amount,  75,000,000  acres  are  in  swamps 
entirely  unproductive,  while  150,000,000  acres 
include  land  whose  productivity  could  be  increased 

199 


THE  CAREFUL  INVESTOR 

at  least  20  per  cent,  by  drainage.  This  is  equal  to 
the  combined  area  of  Germany,  Great  Britain, 
Belgium,  and  Holland.  It  is  estimated  that  this 
area  would  sustain  a  population  of  125,000,000, 
and  would  add  $4,000,000,000  a  year  to  the  public 
wealth  of  the  United  States.  In  Florida  alone 
18,000,000  acres  of  land  can  be  reclaimed  by 
drainage. 

These  impressive  figures  give  some  idea  of  the 
problem  before  the  American  farmer  and  the 
American  consumer.  The  farmer  must  have  more 
capital.  Mr.  James  J.  Hill,  a  few  years  ago, 
aroused  much  discussion  by  the  statement  that 
the  railroads  of  the  United  States  required  a  capi- 
tal investment  of  $1,000,000,000  a  year  for  at 
least  five  years  in  order  to  fit  them  to  handle 
economically  the  traffic  which  would  be  offered. 
The  needs  of  the  railroads  are  insignificant  com- 
pared with  the  needs  of  the  farms.  The  crying 
need  of  the  United  States  to-day  is  for  larger 
investment  in  agriculture. 

The  need  of  a  large  investment  in  farm  mort- 
gages is  great.  Without  this  investment,  the 
problem  of  the  future  food  supply  is  certain  to 
grow  more  and  more  perplexing.  And  yet,  with 
the  present  machinery  of  farm  investment,  it  is 

200 


THE  MORTGAGE  BANK 

unreasonable  to  expect  any  large  increase  in  the 
movement  of  money  into  this  field.  The  method 
of  investment  in  the  farm  mortgage  has  already 
been  explained.  The  investor  in  Pennsylvania  or 
in  New  York  must  lend  $3,000,  $5,000,  or  $10,000 
to  a  man  in  Oklahoma  or  Nebraska  or  North 
Dakota  whom  he  has  never  seen,  and  whom  he 
knows  only  through  the  statements  made  to  him  by 
the  broker.  This  loan  is  for  a  limited  time.  At  the 
end  of  that  time,  he  fears  that  his  money  may  be 
handed  back  to  him,  and  he  will  have  to  make  a 
new  investment,  shifting  and  changing  from  one 
thing  to  another.  If  he  deals  with  reliable  brokers 
whose  names  he  can  readily  obtain  through  his 
local  bank,  he  runs,  it  is  true,  no  risk  of  loss,  but 
the  form  of  the  investment  does  not  commend 
itself  to  him. 

The  Eastern  investor  is  accustomed  to  purchas- 
ing stocks  and  bonds  of  the  large  railroad  and 
industrial  and  public-service  corporations,  issued 
in  $50,000,000,  $100,000,000,  and  $200,000,000 
lots.  He  buys  standard  securities — issued  by 
wealthy  corporations  with  whose  operations  and 
history  he  has  long  been  familiar,  and  which  he 
regards  as  permanent  institutions.  It  is  natural 
that  he  should  prefer  ^]4  and  5  per  cent,  income 

201 


THE  CAREFUL  INVESTOR 

from  a  railway  bond  or  railway  stock  issued  by 
such  companies,  to  6  per  cent,  on  a  farm  mortgage. 

This  prejudice  in  favor  of  standard  securities 
will  not  soon  be  overcome.  The  farm-mortgage 
business  has  been  vigorously  pushed  for  many 
years,  and  yet  other  fields  of  investment  which 
have  been  recently  opened,  such,  for  example,  as 
the  industrials,  have  absorbed  several  billions  of 
dollars  which  it  would  have  been  to  the  national 
interest  to  put  into  farm  mortgages.  The  farm- 
mortgage  broker,  with  his  present  organization, 
cannot  win  the  favor  of  the  investor.  If  the  farm 
mortgage  is  to  reach  the  position  which  it  deserves, 
the  organization  of  the  business  must  be  changed, 
the  institution  of  the  mortgage  bank  must  be 
established  in  this  country. 

The   mortgage   bank  is   well   known   in   every 

country  of  Western  Europe.     In  Germany,  as  a 

recent  investigation  showed,  there  were  36  mortgage 

banks  with  capital  of  $170,563,000  and  combined 

reserves  of  $66,711,400.    These  banks  had  $2,618,- 

000    loaned    out    on    mortgage.      Against    these 

mortgages    and    to    obtain    the    money    for    this 

investment,  the  banks  had  issued  $2,548,000,000 

in  bonds.     Of  this  amount  $1,571,000,000  were 

4  per  cent,  bonds  and  $977,000,000  were  3^2  and 

202 


THE  MORTGAGE  BANK 

$J4  psr  cent.  The  German  mortgage  banks,  by 
standardizing  the  farm  mortgage,  have  been  able 
to  sell  their  bonds  on  better  terms  than  the 
American  railroads  can  obtain  for  their  first- 
mortgage  securities. 

The  mortgage  bank  gathers  together  thousands 
of  individual  loans,  consolidates  them  into  one 
aggregate  security,  and  upon  this  security  issues 
a  standard  bond.  In  addition  to  the  security  of 
the  mortgages,  there  is  the  capital  and  accumu- 
lated earnings  of  the  banks.  The  same  institu- 
tion, although  less  highly  developed,  is  found  in 
France,  Russia,  Austria,  Italy,  and,  more  recently, 
in  Great  Britain. 

From  the  standpoint  of  the  borrower,  the  mort- 
gage bank  offers  great  advantages.  The  American 
method  of  borrowing  on  farm  security  is  to  make  a 
short-term  loan  from  three  to  five  years.  At 
maturity,  this  loan  is  often  reduced  or  paid  off, 
and  money  which  should  properly  go  into  the 
development  of  the  farm  is  used  to  reduce  the 
loan.  If  the  loan  cannot  be  paid  off,  a  new  loan 
must  be  placed,  and  this  means  a  commission 
and  material  increase  in  the  expense.  A  farmer 
who  renews  his  mortgage  from  time  to  time  is 

fortunate  to  escape  with  a  total  cost  of  7>^  per 

203 


THE  CAREFUL  INVESTOR 

cent,  on  the  money  which  he  obtains,  and,  on 
this  account,  the  farm  mortgage  is  always  looked 
upon  as  a  burden  which  often  becomes  a  curse. 

We  find  nothing  of  this  kind  in  the  railway 
field.  Railway  bonds  are  never  paid  off.  When 
they  come  due,  they  are  refunded  into  new  bonds. 
The  investor  does  not  wish  his  money  back;  he 
merely  wishes  security  for  his  income.  As  long 
as  security  can  be  furnished  him,  he  knows  that 
he  can  obtain  the  amount  of  his  principal  from 
some  other  investor  to  whom  he  can  pass  on  the 
evidence  of  indebtedness  in  which  he  has  placed 
his  savings.  He  would  have  the  same  attitude 
toward  the  farm  mortgage  if  this  were  offered  to 
him  as  a  standard  security  instead  of  a  small  loan 
made  on  minute  security  to  a  stranger. 

Farm-mortgage  banking  in  the  llnited  States 
has  been  attempted  in  the  past  with  disastrous 
results.  During  the  eighties,  the  rapid  develop- 
ment of  the  western  portion  of  the  Corn  Belt 
encouraged  many  brokers  to  market  the  bonds 
of  such  companies,  secured  by  Western  farm 
mortgages.  A  succession  of  crop  failures  through- 
out this  region  ruined  many  of  these  companies. 
The  failure  of  the  Lombard  Investment  Company, 

for  example,  inflicted  heavy  losses  upon  the  East- 

204 


THE  MORTGAGE  BANK 

em  investors.  Mortgage  banking,  from  these 
unfortunate  experiences,  fell  into  serious  discredit, 
and  it  is  only  recently  that  interest  in  the  subject 
has  revived.  It  is  to  be  hoped,  in  the  interest 
of  the  nation's  prosperity,  and  in  order  to  place 
sound  securities  within  the  investor's  reach,  that 
this  institution  which  has  been  perfected  in  Europe 
shall  be  speedily  introduced  into  the  United  States. 


^'^ 


XVIII 

INDUSTRIAL  BONDS  AND  RAILROAD 
BONDS  COMPARED 

By  industrial  bonds  we  understand  the  bonds 
of  manufacturing  companies,  corporations  pro- 
ducing iron,  steel,  machinery  of  various  kinds, 
textiles,  refined  sugar,  etc.  We  exclude  from  the 
classification  of  industrial  bonds  the  bonds  of 
mining  companies,  and  the  bonds  of  so-called 
public  service  corporations  which  supply  gas, 
water,  light,  and  transportation  to  municipalities. 

The  investor  must  exercise  great  caution  in 
purchasing  industrial  bonds.  These  bonds  are 
attractive  in  that  they  usually  pay  s}4  and  6 
per  cent,  interest,  and  can  frequently  be  purchased 
at  prices  sufficiently  below  par  to  add  considerably 
to  this  yield.  Their  security,  however,  is,  as  a 
class,  by  no  means  so  good  as  the  security  of  the 
other  classes  of  bonds  which  we  have  investigated. 

The  bond-buyer,  it  should  be  remembered,  sur- 
renders a  chance  of  participating  in  the  increasing 
earnings  of  the  company  in  exchange  for  a  guar- 
antee of  a  fixed  rate  of  return  on  his  investment. 

206 


INDUSTRIAL  BONDS  COMPARED 

If  this  guarantee  is  in  any  way  doubtful,  the  low 
price  and  the  high  interest  return  at  which  the 
bonds  can  be  purchased  will  usually  be  found  to 
be  insufficient  insurance  against  the  risks  of  loss. 
Manufacturing  companies,  as  a  rule,  cannot  give 
these  satisfactory  guarantees  of  security. 

The  causes  of  this  inferiority  of  security  can 
be  best  understood  by  comparing  manufacturing 
industry,  from  the  standpoint  of  permanence  of 
the  income  out  of  which  the  interest  on  the  bonds 
must  be  paid,  with  that  industry  upon  which 
most  of  the  securities  of  the  United  States  are 
based — the  business  of  railway  transportation. 
The  bonds  of  manufacturing  companies  are  in- 
ferior to  railway  bonds  for  the  following  reasons: 

First :  The  demand  for  any  manufactured  prod- 
uct is  less  stable  than  the  demand  for  railway 
transportation  in  the  same  territory. 

Second:  Manufacturing  companies  are  more 
exposed  to  competition  than  railway  companies. 

Third :  The  location  of  manufacturing  industry 
is  more  liable  to  frequent  changes. 

Fourth:  The  personal  equation  enters  more 
largely  into  the  management  of  manufacturing 
companies  than  into  railway  management. 

Fifth:  Manufacturing  industry   is   more   com- 

207 


THE  CAREFUL  INVESTOR 

plex,  less  visible,  and,  therefore,  less  easily  under- 
stood by  the  investor  than  the  business  of  railway 
transportation. 

Let  us  take  these  points  up  in  order.  The  de- 
mand for  the  products  of  a  single  industry,  such 
as  steel,  is  limited  to  a  small  portion  of  the  total 
nimiber  of  commodities  produced.  There  are  a 
thousand  articles  clamoring  for  the  money  of  the 
consumer.  At  best  each  commodity  can  absorb 
only  a  portion  of  the  demand.  The  demand  for 
railway  transportation,  on  the  other  hand,  is 
represented  by  every  commodity  of  commerce. 
It  corresponds  very  closely  to  the  entire  supply 
of  commodities  produced.  What  is  wanted  in 
the  earnings  of  a  company  to  make  its  bonds 
secure  is  stabiHty.  Wide  fluctuations  in  earnings, 
which  bring  them  down  close  to  the  limit  of  fixed 
charges,  always  impair  the  security  of  the  bonds. 
It  is  an  acknowledged  principle  of  trade  that 
the  broader  the  demand  for  the  products  of 
services  of  an  industry,  the  more  stable  are  its 
earnings.  This  principle  is  based  upon  the  obser- 
vation that  a  large  and  diversified  demand  is  but 
slightly  affected  by  any  single  influence,  while 
if  this  influence  is  left  to  operate  by  itself  upon 
the  price  of  a  commodity  or  service,  it  produces 

208 


INDUSTRIAL  BONDS  COMPARED 

wide  fluctuations.  The  withdrawal  of  10,000  gal- 
lons from  a  stand-pipe  appreciably  affects  the 
level  of  water  in  the  pipe.  If  the  same  amount  is 
withdrawn  from  the  reservoir,  however,  there  is 
no  visible  change.  This  illustration  may  be  used 
to  explain  the  |||stability  of  the  demand  for  rail- 
way transportation  as  compared  with  the  demand 
for  coal,  sugar,  or  steel.  The  railroad  company 
is  patronized  by  the  producers  of  every  commodity. 
What  it  loses  in  freight  earnings  from  a  decline  in 
price  or  supply  of  one  group  of  products,  it  often 
more  than  regains  by  advances  in  others. 

The  manufacturing  company,  on  the  other  hand, 
producing,  at  the  most,  only  a  small  number  of 
products,  has  no  such  compensation  for  a  falling- 
off  in  demand.  It  cannot  turn  its  plant  to  pro- 
ducing something  else.  The  steel  plant,  for  ex- 
ample, cannot  turn  to  sugar,  or  the  cotton  mill  to 
the  production  of  shoes.  A  railroad,  however, 
can  turn  from  the  transportation  of  hard  coal 
to  the  transportation  of  soft  coal,  or  from  the 
transportation  of  grain  to  the  transportation 
of  manufactured  goods,  or  from  carrying  iron  ore 
to  carrying  sand,  stone,  and  cement.  It  has  a 
thousand  uses  for  its  plant,  while  the  manu- 
facturing company  has  only  one.  The  classi- 
14  209 


THE  CAREFUL  INVESTOR 

fied  freight  traffic  of  the  Pennsylvania  Railroad, 
for  example,  contains  36  general  classes  of  freight, 
some  of  which  comprise  thousands  of  individual 
articles,  and  all  of  which,  taken  together,  make 
up  the  143,928,382  tons  hauled  by  the  Pennsyl- 
vania Railroad  in  191 2.  Each  one  of  the  manu- 
factured commodities  which  the  Pennsylvania 
Railroad  carries  is  produced  by  some  industrial 
concern.  Each  one  of  these  commodities  is  acted 
upon  by  a  variety  of  influences  which  affect  its 
supply  and  demand,  and  through  these  increase 
or  diminish  the  profits  of  the  business  which 
produces  it. 

The  production  of  anthracite  coal,  for  example, 
is  reduced  by  a  strike.  As  a  result,  the  demand  for 
bituminous  coal  is  increased.  A  failure  of  the 
corn-crop  reduces  the  profits  of  the  farmer  and 
stock-raiser.  A  reduction  of  the  tariff  lessens  the 
profits  of  the  sugar-refiner,  and  a  reduction  of  the 
internal  revenue  duty  on  manufactured  tobacco 
increases  the  profits  of  the  tobacco  trust.  Profits 
and  prices  are  in  a  state  of  constant  change.  No 
manufacturing  industry  can  be  certain  of  its 
earnings  a  year  hence. 

But  from  these  perturbations  of  commerce,  the 
railway  company  is,  to  a  large  extent,  protected. 

210 


INDUSTRIAL  BONDS  COMPARED 

The  immense  variety  of  its  traffic  prevents  rapid 
changes  in  the  gross  amount.  What  is  lost  on 
one  commodity  is  often  regained  on  another, 
and  the  total  tonnage  is  not  reduced.  The  experi- 
ence of  the  Pennsylvania  Railroad,  during  the 
anthracite  strike  of  1902,  is  in  point.  This  road 
hauls  both  anthracite  and  bituminous  coal.  As 
a  result  of  the  strike,  the  anthracite  traffic  was 
cut  off,  and  the  anthracite  railroads,  such  as  the 
Reading  and  the  Lehigh  Valley,  suffered  a  heavy 
loss.  But  the  Pennsylvania  hauled  a  large  part 
of  the  bituminous  coal  which  took  the  place  of 
anthracite  in  the  Eastern  markets,  and  the  in- 
creased earnings  from  this  source  more  than  offset 
the  loss  on  anthracite  coal. 

Manufacturing  industry  shows  no  such  tend- 
encies toward  stability.  On  the  contrary,  manu- 
facturing industry  is  growing  constantly  more 
specialized.  In  place  of  producing  all  kinds  of 
shoes,  for  example,  the  shoe-manufacturer  comes 
to  specialize  in  women's  and  children's  shoes,  and 
then  in  women's  shoes  alone.  A  manufacturer 
of  machine  tools,  as  the  demand  for  his  product 
increases,  will  gradually  concentrate  his  produc- 
tion upon  lathes,  and  eventually  he  may  concen- 
trate on  a  single  type  of  lathe  for  specialized  work. 

211 


THE  CAREFUL  INVESTOR 

Large  advances  in  specialization  increase  the 
liability  to  wide  fluctuations  in  demand,  corre- 
sponding changes  in  profits,  and  resulting  insta- 
bility of  security. 

Manufacturing  industry  is  more  exposed  to 
competition  than  the  railroad.  A  railroad  com- 
pany has  a  natural  monopoly.  After  the  terri- 
tory through  which  its  line  passes  has  been  fully 
settled,  and  the  day  of  state  and  local  donations 
of  land  and  cash  has  passed  away,  competition 
becomes  very  difficult.  More  especially  is  this 
true  because  of  the  increasing  expense  of  terminals 
in  large  cities.  The  Baltimore  and  Ohio  was 
forced  into  bankruptcy  in  1896,  among  other 
causes,  by  the  cost  of  its  entrance  into  Philadel- 
phia, where  it  hoped  to  compete  with  the  Penn- 
sylvania; and  the  Gould  interests,  after  spending 
$30,000,000  in  an  attempt  to  gain  a  foothold  in 
Pittsburgh,  have  been  practically  forced  from  the 
field  of  competition  in  that  city.  Even  where 
railway  competition  exists  between  the  larger 
cities,  the  local  traffic  is  generally  free  from  its 
influence.  Moreover,  the  way  and  structure  of  a 
railroad  may  be  considered  as  a  permanent  plant 
to  which  the  company  is  constantly  adding.  Rail- 
way equipment  changes  very  slowly,  and  no  faster 

212 


INDUSTRIAL  BONDS  COMPARED 

than  it  is  worn-out.  A  well  managed  manufac- 
turing concern,  on  the  other  hand,  is  constantly 
throwing  into  the  scrap  pile  valuable  machinery 
which  has  been  supplanted  by  some  new  inven- 
tion, which  must  be  installed  in  order  to  meet 
competition. 

As  a  railroad  grows,  the  value  of  its  property  is 
constantly  being  added  to,  and  the  cost  of  dupli- 
cating it  increases  to  a  point  which  renders  it 
almost  immune  from  the  danger  of  competition. 

Manufacturing  industry  is  seldom  free  from 
competition.  Even  the  United  States  Steel  Cor- 
poration, with  all  its  advantages,  has  been  unable 
to  retain  the  control  of  the  market  of  the  steel 
trade  in  the  United  States  with  which  it  started. 
Its  percentage  of  the  total  production  has  gone 
steadily  down.  Now  that  the  Sherman  law  is 
being  so  effectively  enforced,  the  possibility  of 
monopoly  in  manufacturing  industry  may  be  con- 
sidered even  more  remote,  since  the  combinations 
by  which  the  monopoHes  of  the  past  have  been 
built  up  are  put  under  the  ban. 

Even  the  patent  monopoly  is  subject  to  such 

conditions  and  limitations  as  to  render  it  of  little 

value  in  furnishing  security  for  bond-issues.     A 

patent   expires   at   the   end   of   seventeen   years. 

213 


THE  CAREFUL  INVESTOR 

The  originality  of  the  invention  must  be  tested 
in  court  before  the  patentee  can  be  certain  of 
legal  protection  in  his  right.  If  the  invention 
proves  valuable,  there  are  always  men  or  corpo- 
rations who  will  attack  its  originality  in  the  hope 
of  either  invalidating  the  invention  in  whole  or 
in  part,  or  of  receiving  money  to  withdraw  their 
claim.  A  recent  illustration  is  the  invention  of 
the  Taylor-White  process  for  the  manufacture  of 
tool  steel,  from  which  the  owners  for  a  number 
of  3^ears  drew  a  large  income,  but  which  was  finally 
declared  to  be  non-patentable.  It  is  next  to 
impossible,  in  this  day  of  accumulated  knowledge, 
to  hit  upon  something  which  is  absolutely  new. 
Somewhere  in  the  world,  it  may  be  in  an  obscure 
laboratory,  or  in  a  comer  of  some  workshop,  the 
most  promising  invention  has  been  at  least  sug- 
gested, and  a  suggestion  of  anticipation  is  enough 
for  a  contest. 

The  value  of  a  patent,  moreover,  is  constantly 
threatened  by  the  danger  of  substitution.  The 
end  desired  may  be  reached  by  some  other  road 
than  the  one  upon  which  the  patentee  has  the 
exclusive  right  to  travel.  As  soon  as  the  value 
of  a  patent  is  proved,  men  set  to  work  upon  the 

problem  which  it  has  solved  in  the  endeavor  to 

214 


INDUSTRIAL  BONDS  COMPARED 

find  some  other  solution,  and  it  is  but  seldom 
that  one  of  them  does  not  succeed.  The  writer 
knows  of  a  case  where  a  patent  was  granted  for 
an  improvement  in  a  certain  device,  in  which 
the  only  change  was  the  substitution  of  a  weak 
for  a  strong  spring.  As  a  basis  for  the  security 
of  investment,  a  patent  is  worthless.  No  well 
informed  investor  should,  save  in  the  most  ex- 
ceptional cases,  buy  a  bond  of  a  company  whose 
earnings  are  dependent  on  the  monopoly  of  a 
patent. 

Even  those  manufacturing  industries  which 
rely  upon  the  monopoly  of  their  control  of  raw 
material  are  not  secure.  It  was  supposed,  for  a 
number  of  years,  that  the  United  States  Steel 
Corporation  had  achieved  a  practical  monopoly 
of  the  ore  supply  of  the  United  States.  Certainly 
its  control  was  sufficient  to  put  up  the  price  of 
iron  ore  to  a  point  which  made  it  exceedingly 
difficult  for  the  independents,  who  were  obliged 
to  purchase  their  ore,  to  make  any  money.  These 
high  prices  of  ore,  however,  stimulated  the  efforts 
to  uncover  any  new  supplies,  and  brought  into 
use  a  large  number  of  low-grade  ores  found  in  the 
Eastern  States,  which  it  was  not  profitable  to 
work    at    former    ore    prices.      Discoveries    and 

215 


THE  CAREFUL  INVESTOR 

development  in  the  northern  coast  of  the  island 
of  Cuba  also  made  enormous  additions  to  the 
supply  of  available  iron  ore.  At  one  mine  on 
Nipe  Bay,  there  is  in  sight  over  500,000,000  tons 
of  ore,  which  can  be  laid  down  along  the  Atlantic 
Sea-board  at  much  lower  prices  than  this  same 
grade  of  steel  can  be  furnished  from  the  Lake 
Superior  mines. 

The  difficulty  of  achieving  a  monopoly  of  manu- 
facture is  but  another  expression  for  the  liability 
of  manufacturing  industry  to  competition,  and 
competition  is  always  dangerous.  It  is  true  that 
a  combination  of  good  sense  and  good  fortune 
may  achieve  success,  but  the  danger  of  failure  is 
always  present;  and  even  if  success  is  achieved, 
its  measure  may  be  small.  The  constant  immi- 
nence of  competition  makes  the  investor  cautious 
about  buying  the  long-time  bonds  of  a  manu- 
facturing company.  He  may  buy  the  stock,  off- 
setting the  risk  by  the  higher  returns  on  the 
investment;  but  in  a  bond  which  pays,  at  best, 
only  a  moderate  return,  the  maximum  security 
is  demanded. 

The  three  remaining  considerations  with  which 
this  discussion  opened,  bearing  upon  the  infe- 
riority of  manufacturing  bonds  as  compared  with 

216 


INDUSTRIAL  BONDS  COMPARED 

railroad  bonds,  may  be  passed  briefly  in  review. 
The  location  of  manufacturing  industry  is  subject 
to  sudden  changes.  A  large  part  of  the  heavy  iron 
and  steel  trade  which  was  formerly  controlled  by 
Pittsburgh,  is  now  passing  to  the  Chicago  district, 
and  the  Northwest,  it  is  expected,  will  be  served 
from  the  plants  erected  at  Duluth.  The  great 
textile  and  boot  and  shoe  industries  of  New  Eng- 
land are  in  danger  of  arrested  development,  due  to 
the  steady  progress  of  the  sentiment  in  favor  of 
a  strict  application  of  the  long  and  short  haul 
clauses.  New  England  has  been  able  to  live  and 
thrive  because  of  the  exceedingly  low  railroad 
rates  which  they  receive  on  their  raw  materials 
shipped  in  and  on  their  manufactured  products 
shipped  out.  If  the  long  and  short  haul  clause 
is  strictly  applied,  and  the  railroad  prevented 
from  charging  the  same  rate  for  a  long  haul  as 
it  charges  for  short  distances,  the  industries  of 
New  England  must  seek  new  outlets  in  the  foreign 
trade  for  the  domestic  business  which  will  be  lost 
to  them  by  the  developments  in  the  "West  and 
the  South. 

The  personal  equation  is  far  more  important 
in  manufacturing  industry  than  in  railroading. 
Take,   for  example,    the   immense   strides   which 

217 


THE  CAREFUL  INVESTOR 

the  Bethlehem  Steel  Company  has  been  making 
under  the  leadership  of  Charles  M.  Schwab, 
whose  superior  as  a  steel  producer  does  not  exist 
in  the  United  States.  Compared  with  his  achieve- 
ments, the  record  of  the  United  States  Steel 
Corporation  makes  but  a  sorry  showing.  In  man- 
ufacturing, the  processes  and  machinery  are  so 
complex,  and  the  necessity  for  change  and  im- 
provement is  so  constant,  that  the  ability  of  the 
manager  is  often  the  deciding  factor  in  the  success 
of  the  concern. 

Compared  with  the  railroad,  this  inferiority 
of  manufacturing  is  especially  conspicuous.  The 
operations  of  a  railroad  are  simple  and  uniform. 
They  repeat  themselves  under  all  conditions  and 
in  every  section.  The  appliances  of  a  railroad 
are  also  relatively  simple,  and  easy  to  understand 
and  operate.  A  locomotive  engine  is  the  most 
complicated  machine  of  a  railwa}'',  and  the  mechan- 
ism of  a  locomotive  is  relatively  simple.  Rail- 
roading has  been  called  an  exact  science.  There 
is  little  difficulty  in  filling  vacancies  in  the  most 
important  positions.  Railway  operation  is  now 
largely  a  matter  of  uniform  routine,  coupled  with 
sound   judgment   in   financial   management,    and 

tact   and   diplomacy   in   conducting  negotiations 

218 


INDUSTRIAL  BONDS  COMPARED 

with  the  pubhc  and  with  the  employees.  The 
investor  in  railway  bonds  may  justly  concern 
himself  with  the  financial  management  of  a 
property,  but  he  can  now  be  confident  that  the 
security  of  his  bonds  will  seldom  be  impaired  by 
blunders  in  the  operating  or  construction  depart- 
ments. ^^ 
"The  final  consideration  affecting  the  relative  )^ 
value  of  railway  and  industrial  bonds,  is  what 
may  be  called  the  '  comprehensibility '  of  the 
two  industries.  The  railroad  is  visible.  The 
bond-buyer,  it  may  be,  rides  daily  over  a  portion 
of  its  lines.  Its  equipment  and  its  operations  are 
always  in  evidence.  He  can  see  the  property  and 
can  understand  its  workings.  This  character  of 
simplicity  extends  even  to  its  reports.  A  properly 
kept  railway  report,  to  a  man  of  average  intelli- 
gence in  such  matters,  is  plain  reading.  The 
operations  of  a  railway  company  consist  in  trans- 
porting a  certain  number  of  tons  of  freight  and  a 
certain  number  of  passengers,  for  a  certain  amount 
of  money.  Its  expenses  are  easily  understood. 
Its  equipment  can  be  enumerated  in  detail.  The 
investor  can  follow  its  history  from  one  year  to 
another,  and  is  not  obliged  to  employ  an  expert 
to  explain  its  reports  to  him." 

219 


THE  CAREFUL  INVESTOR 

"  But  the  manufacturing  company  has  none  of 
these  advantages.  Its  plant  is  largely  visible. 
A  holder  of  United  States  Steel  bonds  might 
obtain  permission  to  go  through  one  of  the  plants, 
but  he  would  run  some  risk  in  doing  so.  His 
clothing  would  be  burned  into  holes  by  flying 
sparks.  He  would  have  to  dodge  locomotive 
engines  running  at  top  speed  around  comers. 
He  would  be  almost  deafened  by  the  noise,  and 
often  scorched  by  the  heat.  Moreover,  for  all 
his  pains,  he  would  understand  very  little  of  what 
he  saw,  and  he  would  not  care  to  repeat  the 
experience.  The  full  report  of  such  a  company 
would  be  equally  unintelligible  to  the  initiated. 
What  does  he  know  about  a  universal  plate  miU, 
or  a  Wellman-Seaver  charging  machine,  or  a 
Jones  mixer?  Probably  nothing.  He  has  never 
seen  these  important  appliances  of  a  steel-mill, 
probably  never  will  see  them,  and  would  under- 
stand little  about  them  if  he  should  see  them. 
The  technical  jargon  of  an  engineer's  report  would 
be  equally  imintelligible.  An  inventor  who  pur- 
chases industrial  bonds  buys  into  a  company  of 
whose  equipment  and  operations  he  usually  under- 
stands very  little.     I  would  not  be  understood  to 

condemn    the    entire    class    of   industrial    bonds. 

220 


INDUSTRIAL  BONDS  COMPARED 

There  are  to  be  found  bonds  of  manufacturing 
industries,  especially  those  issued  under  the 
serial  plan,  where  the  principal  is  rapidly  extin- 
guished out  of  earnings  which  are  reasonably 
secure.  The  high  yield  of  these  bonds  is  also 
attractive.  There  is  no  reason,  however,  why  any 
one  should  buy  an  industrial  bond  to  yield  less 
than  6  per  cent.,  even  upon  the  soundest  recom- 
mendations and  after  the  most  careful  investi- 
gation; and  six  per  cent,  with  much  better  secur- 
ity, can  be  obtained  from  a  great  variety  of 
investments."^ 

1  Quoted  from  the  author's  Trust  Finance. 


XIX 

TIMBER  BONDS 

Ten  years  ago  any  first-class  banking  house 
in  the  United  States  would  have  immediately 
rejected  a  proposition  to  buy  three  or  five  million 
dollars  of  bonds  secured  by  a  first  mortgage  on 
standing  timber.  Such  an  undertaking  would 
have  been  looked  upon  as  too  hazardous.  The 
investor  could  not  have  been  persuaded  to  put 
his  money  into  such  securities. 

Of  late  years,  however,  with  the  steady  advance 
in  the  cost  of  living,  and  the  resulting  insistent 
demand  for  a  higher  rate  of  return  on  invest- 
ments, combined  with  the  rapid  development  of 
financial  technique  in  investigating  opportunities 
for  investment,  and  in  formulating  plans  of  cap- 
italization and  financial  management,  standing 
timber  is  becoming  the  basis  of  bonds  which  fully 
deserve  the  title  of  investment  securities. 

The  basis  of  the  security  in  timber  bonds  is  the 

steadily  diminishing  timber  supply  of  the  United 

States.    The  consumption  of  lumber  per  capita  in 

this  country  is  rapidly  increasing.    From  1880  to 

222 


TIMBER  BONDS 

1900,  the  increase  in  population  was  52  per  cent, 
and  the  increase  in  the  lumber  cut  was  94  per 
cent.  In  1880,  18,000,000,000  feet  of  timber  was 
cut  in  the  United  States;  in  1907,  40,000,000,000 
feet.  The  total  amount  of  standing  timber  in 
the  United  States,  including  that  which  is  held 
by  the  government  as  forest  reserve,  as  reported 
by  the  Bureau  of  Forestry,  is  2,500,000,000,000 
feet.  This  supply  is  being  exhausted  at  the  rate 
of  100,000,000,000  feet  a  year,  and  the  prices  of 
all  kinds  of  timber  are  steadily  advancing.  The 
average  annual  export  price  of  lumber  in  1896 
reached  its  lowest  figure  at  $14.56  per  thousand 
feet;  in  191 1  the  price  of  the  same  product  was 
$21.55,  ^^  increase  of  48  per  cent.  This  rapid 
increase  of  price  is  an  indication  of  the  fact  that 
at  the  present  rate  of  cutting,  the  supply  of 
timber  in  the  United  States  will  be  exhausted 
in  from  20  to  25  years.  The  holders  of  timber 
land  in  this  country  possess  one  of  the  strongest 
natural  monopolies,  a  monopoly  whose  value  is 
certain  to  increase  even  over  the  present  extra- 
ordinary figure. 

The  successful  efforts  of  the  lumber  interests 
to  raise  large  amounts  of  capital  by  the  sale  of 

bonds  have  been  prompted  by  the  change  in  the 

223 


THE  CAREFUL  INVESTOR 

organization  of  the  industry.  Until  recent  years, 
the  logging  and  milling  of  timber  were  carried 
on  by  two  sets  of  producers.  An  accurate  picture 
of  the  old  days  in  the  lumber  industry  is  given  in 
Stewart  Edward  White's  "The  Riverman."  The 
logging  firms  were  the  owners  of  timber  land  and 
cut  out  a  supply  of  logs  each  winter.  These  logs 
they  would  float  down  the  river  to  the  mills  where 
they  would  be  sold.  Prices  of  timber  land  were 
low  and  payments  were  easy.  Only  a  small 
amount  of  capital  was  required. 

This  situation  has  now  entirely  changed.  All 
branches  of  the  industry  are  concentrated  under 
a  single  ownership.  One  company  owns  its  own 
timber  lands,  does  its  own  logging  and  milling, 
and  in  some  cases  sells  its  own  product.  The 
amount  of  capital  required  to  operate  a  business 
of  this  character  is  very  large.  In  the  first  place, 
the  timber  holdings  must  be  large  to  warrant  the 
construction  of  a  modem  mill,  which  is  a  costly 
affair,  and  to  supply  it  with  material  for  an  ex- 
tended period  of  years.  The  logging  equipment 
now  includes  complete  steam  railways.  The  log- 
ging and  the  expense  of  getting  out  the  logs  is 
much  greater.    With  the  rise  in  the  price  of  timber 

land,  an  enormous  amount  of  money  is  tied  up 

224 


TIMBER  BONDS 

for  a  long  term  of  years,  to  be  collected  only  in 
small  amounts  as  the  trees  are  cut.  The  lumber 
operator  is  obliged  to  extend  credit  for  periods 
up  to  six  months.  His  taxes  are  constantly  in- 
creasing, and  he  must  meet  his  freight-bills  and 
pay-rolls  promptly. 

Few  persons  who  are  not  conversant  with  lum- 
ber investments  are  familiar  with  the  extent  of 
the  operations  of  some  of  these  lumber  companies. 
For  example,  one  of  the  Southern  lumber  com- 
panies owns  550,000  acres  of  cypress  and  yellow 
pine,  containing  3,400,000,000  feet  of  timber,  in 
Georgia  and  South  CaroHna.  This  company  has 
a  net  working  capital  of  more  than  $950,000.  Its 
seven  mills  and  their  equipment  are  valued  at 
$1,250,000.  In  1912  the  output  of  this  company 
was  140,000,000  feet.  Another  company,  oper- 
ating in  the  far  West,  owns  70,000  acres  of  virgin 
timber  lands  in  Western  Oregon,  which  are  esti- 
mated to  contain  over  4,300,000,000  feet  of  fir, 
cedar,  and  other  timber.  The  manufacturing 
plant  of  this  company  is  valued  at  $200,000  and 
has  a  capacity  of  150,000  feet  for  each  ten-hour 
day. 

In  recent  years  it  has  been  found  impossible 
by  the  lumber  companies  to  handle  their  rapidly 
15  225 


THE  CAREFUL  INVESTOR 

growing  business  with  the  capital  derived  from 
their  own  operations.  The  investment-banker 
has,  therefore,  been  appealed  to,  to  furnish  funds. 
The  result  has  been  the  issuance  of  a  type  of  bond 
which  combines  high-grade  security  with  high 
interest.  One  bond-house  in  Chicago,  which  has 
specialized  on  this  type  of  security,  has  already 
sold  over  $40,000,000  of  timber  bonds. 

Timber  bonds  are  peculiar  among  industrial 
securities  in  that  they  are  issued  against  property 
which  already  exists  and  which  can  be  accurately 
measured.  A  bond  issued  on  the  security  of  rail- 
road property  depends  upon  the  continued  profit- 
able operation  of  the  railroad.  A  rate  war,  or  a 
change  in  management,  or  a  long-continued  in- 
dustrial depression,  may  reduce  net  earnings 
below  the  level  of  fixed  charges.  No  matter  how 
costly  the  property  of  the  railroad,  the  corpora- 
tion may  be  forced  into  bankruptcy,  and  the 
bond-holders  suffer  loss.  The  farm  mortgage 
depends  for  its  security  upon  the  regular  and 
profitable  operation  of  the  farm.  Bonds  issued 
on  the  security  of  minerals,  with  the  possible 
exception  of  anthracite-coal  bonds,  are  likely  to 
be  disturbed  by  the  discovery  of  new  supplies 
of  the  same  mineral. 

226 


TIMBER  BONDS 

The  vsupply  of  timber,  however,  is  known  and 
fixed.  The  trees  can  actually  be  measured  and 
counted.  Their  value  is  known,  and  that  value  is 
steadily  increasing.  All  that  is  required,  there- 
fore, to  make  these  bonds  a  safe  investment,  is 
that  the}^  should  be  issued  by  an  established  com- 
pany in  high  credit  and  managed  by  experienced 
lumber  men;  that  the  lands  should  contain  a 
known  amount  of  timber  of  good  quality,  the 
exact  amount  to  be  ascertained  by  timber  esti- 
mators employed  by  the  banking  house;  that 
the  titles  to  the  land  should  be  found  perfect; 
and  that  the  mortgage  securing  the  bonds  should 
contain  provisions  which  will  provide  for  the 
repayment  of  a  certain  amount  of  the  principal 
at  fixed  intervals,  so  that,  before  the  timber  is 
exhausted,  the  bonds  will  have  been  paid. 

How  carefully  these  requirements  are  complied 

with,  in  the  issuing  of  timber  bonds,  may  be  seen 

from   a   recent   bond   offering   by   an   important 

Boston  house.     The  amount  of  the  issue  in  this 

case  was  $6,000,000  of  6  per  cent,  bonds.    These 

bonds  begin  to  mature  in  July,   1914,  and  are 

finally  paid  off  in  serial  instalments  on  July   i, 

1922,    the   instalments   rising   from   $250,000    to 

$375,000.     This  is  an  example  of  the  well  known 

227 


THE  CAREFUL  INVESTOR 

plan  of  serial  bond  issues.  The  property  of  the 
company  is  valued  at  $16,800,000,  or  2.8  times 
this  issue.  Provision  for  the  repayment  of  the 
bonds  is  made  by  a  sinking  fund,  which  places 
in  the  hands  of  the  trustees,  for  every  thousand 
feet  cut  by  the  company's  mills,  $3.50.  Before 
the  first  instalment  falls  due,  the  accumulation 
in  the  sinking  fund  will  amount  to  $250,000.  As 
a  result  of  the  operation  of  this  sinking  fund,  the 
margin  of  security  for  the  investor  is  steadily 
increasing.  At  the  outside,  the  bonds  will  repre- 
sent $1.76  per  thousand  feet  of  standing  timber. 
This  will  be  reduced,  by  the  operation  of  the 
sinking  fund,  to  $1.40  per  thousand  feet  on 
January  i,  1917,  to  89  cents  per  thousand  feet  on 
July  I,  19 1 9,  and  to  27  cents  per  thousand  feet 
of  standing  timber  on  July  i,  1921. 

This  company  operates  in  a  district  which  has 
never  been  disturbed  or  seriously  damaged  by 
fire.  The  mortgage  securing  the  bonds  provides 
that  the  saw-mills  and  manufactured  lumber  shall 
be  fully  protected  by  fire  insurance.  The  Com- 
pany has  been  in  successful  operation  for  40  years. 
It  is  managed  by  men  experienced  in  timber  invest- 
ment and  saw-mill  operations,  who  own  practically 
the  entire  capital  stock  of  the  company.     The 

228 


TIMBER  BONDS 

proceeds  of  the  issue  are  employed  for  additional 
working  capital  and  to  increase  the  timber  re- 
serves. The  net  earnings  of  the  company  for  the 
present  year  are  estimated  at  $1,000,000,  as  com- 
pared with  the  interest  requirement  on  the  bonds 
of  $360,000. 

These  statements  are  made  by  the  banking 
house  on  the  basis  of  a  careful  investigation. 
The  bankers  themselves  verify  the  statements 
made  on  behalf  of  the  management  as  to  the 
history  of  the  company,  and  the  standing  of  those 
in  control  of  it.  For  the  financial  results  of  the 
operation,  the  bankers  rely  upon  the  examination 
of  chartered  accountants.  The  report  of  these 
accountants  they  submit  in  connection  with  the 
offering  of  the  bonds.  In  this  case,  the  account- 
ants' report  showed  that  the  average  manufac- 
turing profits  for  the  past  6  years  have  been 
$5.81  per  thousand  feet  of  lumber  sold. 

The  most  important  investigation  made  on 
behalf  of  the  bankers  is  the  amount  of  standing 
timber.  This  report  is  signed  by  Mr.  W.  E. 
Straight,  one  of  the  leading  timber  experts  in 
the  United  States,  whose  name  on  a  report  is 
positive  proof  of  a  thorough  preliminary  examina- 
tion.    The  method  employed  by  Mr.  Straight  is 

229 


THE  CAREFUL  INVESTOR 

described  in  a  booklet  issued  by  Messrs.  Clark  L. 
Poole  &  Co.  of  Chicago,  one  of  the  leading  bank- 
ing houses  in  this  line,  in  part  as  follows : 

All  corners  having  been  established,  Mr.  Straight  assigned 
the  crews  to  work.  They  were  started  at  different  points  and 
worked  to  a  common  centre,  with  the  intention  to  have  all  the 
crews  meet  about  the  same  time.  Each  crew  is  furnished  with 
plans  of  the  different  portions  of  the  land  allotted  to  it,  the 
descriptions  all  being  checked  from  the  original  deeds  to  the 
property.  ...  A  camp  will  be  occupied  on  an  average  of 
about  ten  days;  and  the  crews  will  cover  from  lo  to  17  sections 
of  land  from  one  camp,  depending  on  the  character  of  the  country. 

Each  crew  covers  on  foot  the  several  portions  of  the  woods 
assigned  to  it.  The  crew  starts  at  some  point  on  the  base  given 
by  the  surveyor  and  continues  to  do  its  work,  keeping  an  accurate 
check  on  its  base  as  the  work  proceeds.  The  method  used  is 
known  as  "horse-shoeing  a  40,"  and  is  the  one  most  commonly 
used  by  Mr.  Straight,  as  it  enables  the  cruiser  to  see  every  por- 
tion of  the  land.  If  the  start  is  made  at  the  southeast  comer  of 
a  section,  the  cruiser  will  say  to  his  compassman:  "Go  to  tally 
I  north."  When  the  compassman,  who  runs  all  the  lines,  has 
gone  north  125  paces,  or  about  375  feet  he  calls  out:  "Tally  i 
north,"  and  stops  until  he  is  directed  to  move.  This  gives  one 
Bide  of  a  ten-acre  tract. 

The  cruiser  has  begun  to  work  toward  the  compassman,  and 
counts  and  estimates  each  and  every  tree  for  a  distance  of  25 
paces  on  each  side  of  his  base  line,  making  50  paces  in  all.  At 
first  he  measures  the  trees  with  a  tape,  to  verify  his  eye  judgment 
of  the  circumference  and  measures  windfalls  for  length  to  verify 
his  eye  judgment  as  to  the  height  of  trees.  If  his  eye  judgment 
has  been  at  fault,  he  keeps  measuring  until  his  eye  judgment 
becomes  accurate,  then  he  trusts  solely  to  his  eye.  He  keeps 
tally  of  each  tree,  and  at  the  close  of  the  day  figures  out  his  totals 
by  an  established  mathematical  rule.     .     .     .     When  the  esti- 

230 


TIMBER  BONDS 

mator  has  finished  his  work  ...  he  has  an  accurate  tally 
of  each  tree  on  eight  acres  of  each  40  acres,  with  its  length  and 
other  dimensions.  In  his  hand  he  has  held  a  card  on  which  he 
has  kept  a  tally.  He  also  carries  a  field  book  in  which  he  notes 
the  topography  of  the  land,  the  location  of  marshes,  lakes,  streams, 
wagon  loads,  logging  railroads,  and  everything  that  comes  within 
his  observation,  together  with  notations  as  to  the  surface  of  the 
ground,  general  logging  chance,  character  of  soil,  etc.  At  night 
he  makes  out  from  his  field  book  an  accurate  plat,  or  timber 
section  and  field  repcfft  sheet,  one  for  each  section  of  land  esti- 
mated. 

It  is  on  the  basis  of  carefully  detailed  work  of 
this  sort,  carried  on  under  the  direct  supervision 
of  the  supervisor,  that  the  banking  house  esti- 
mates the  quantity  of  timber  on  which  it  advances 
money.  When  this  estimate  is  supplemented  by 
a  verification  of  details,  and  by  the  drawing  of  a 
trust  deed  conveying  the  timber  and  all  other 
property  of  the  company,  in  trust  for  the  pay- 
ment of  principal  and  interest  of  the  bonds,  under 
a  variety  of  carefully  drawn  restrictions  which 
practically  eliminate  the  risk  of  careless  financial 
management,  the  banking  house  can  offer  the 
investor  a  6  per  cent,  bond  which  is  as  safe  an 
investment  as  can  be  furnished  him. 


XX 

INDUSTRIAL  PREFERRED  STOCK 

Every  part  of  the  United  States  is  the  seat  of 
old  and  prosperous  manufacturing  enterprises, 
many  of  them  dating  back  to  the  middle  of  the 
last  century,  with  long  records  of  solvency  and 
profit.  Fifteen  years  ago,  when  the  industrial 
trust  movement  started,  a  large  number  of  these 
concerns  were  swept  into  consolidations,  and  their 
owners  seized  the  opportunity  to  retire.  This 
industrial  trust  movement,  however,  was  aimed 
not  at  the  investor,  but  at  the  speculator.  The 
stocks  of  these  much-criticised  combinations  were 
not  sold  by  investment-bankers  to  their  clients, 
but  were  marketed  on  the  public  stock-exchanges 
by  the  methods  of  public  advertising  and  manipu- 
lation. For  a  long  time  the  investor  would  have 
nothing  to  do  with  them. 

Following  the  collapse  of  the  consolidation 
movement,  about  1903,  the  flotation  of  industrial 
preferred  stocks  languished,  and  not  until  the 
last  three  years  has  this  class  of  securities  seri- 
ously engaged  the  attention  of  the  financial  world. 

232 


INDUSTRIAL  PREFERRED  STOCK 

This  time  it  is  not  the  speculative  promoter  who 
creates  the  new  issue,  but  the  investment-banker, 
anxious  to  satisfy  the  insistent  demands  of  his 
clients  for  a  security  which  will  furnish  them 
reasonable  safety  with  a  higher  rate  of  return 
than  they  can  secure  from  the  purchase  of  bonds. 
The  result  has  been  a  large  number  of  preferred 
stock  issues  covering  every  kind  of  business. 
Agricultural  machinery  companies,  canning  com- 
panies, biscuit  companies,  clothing  companies, 
automobile  and  trading  companies,  have  all  con- 
tributed to  supply  the  now  enormous  total  of 
these  industrial  preferred  stocks. 

The  usual  investigations  are  made  by  the 
banker  in  marketing  these  securities.  If  he  is 
conscientious,  however,  he  does  not  recommend 
them  in  the  same  unqualified  terms  as  those  which 
he  employs  in  advocating  the  purchase  of  a  mort- 
gage bond.  The  policy  of  one  very  large  house 
is  to  discourage  the  sale  of  preferred  stocks  to 
the  small  investor.  It  recognizes  that  there  is 
an  element  of  speculation  in  these  securities. 
They  must  be  classified  as  speculative  invest- 
ments. There  are  few  manufacturing  enterprises 
which  are  sufficiently  prosperous  to  guarantee 
seven  per  cent,  to  the  investor  in  good  times  and 

233 


THE  CAREFUL  INVESTOR 

bad.  Those  who  purchase  these  securities  must 
take  the  risk  of  business  depression,  from  which 
the  holders  of  well  selected  bonds  are  now  nearly 
immime. 

The  banker  does  his  best  to  protect  his  client 
who  buys  preferred  stock,  by  inserting  in  the 
contract,  under  which  the  preferred  stock  is 
issued,  a  variety  of  restrictions,  all  of  which  are 
calculated  to  secure  the  investor.  Preferred 
stocks  are  now  universally  made  cumulative  as 
to  dividends,  and  also  as  to  assets.  By  this 
provision,  in  case  a  period  of  depression  should 
force  the  management  to  pass  the  dividend  for 
one  year,  this  unpaid  dividend  must  be  made  up 
before  the  common  stock-holders  can  receive  any- 
thing. There  is  also  a  preference  as  to  assets  in 
the  event  of  liquidation.  In  the  unlikely  event 
that  the  company  should  desire  to  dissolve, 
realize  on  its  property,  and  distribute  the  pro- 
ceeds, the  preferred  stock-holder  would  be  paid 
first. 

An  effort  is  made,  also,  to  enforce  conservative 
financial  management  upon  the  company.  It  is 
almost  universally  provided  that  no  mortgage 
can  be  placed  upon  any  of  the  property  held  by 
the  company  without  the  consent  of  the  holders 

234 


INDUSTRIAL  PREFERRED  STOCK 

of  three-fourths  of  the  preferred  stock.  In  some 
cases  the  company  is  prohibited  from  issuing 
bonds  of  any  kind,  whether  secured  by  mortgage 
or  not,  which  would  rank  ahead  of  the  preferred 
stock,  maturing  more  than  one  year  from  the 
date  of  issue.  Some  restrictions  require  the  com- 
pany to  set  aside  a  sinking  fund  out  of  earnings 
before  any  dividends  are  paid  on  the  common 
stock,  and  to  retire  a  certain  portion  of  the  pre- 
ferred stock  each  year.  Again,  it  is  frequently 
provided  that  the  quick  assets — cash,  good  ac- 
counts receivable,  materials  and  supplies,  and 
half  finished  and  finished  products  of  the  com- 
pany— must  at  all  times  equal  the  amount  of 
preferred  stock  outstanding. 

If  these  requirements  are  not  carried  out  by 
the  directors,  in  addition  to  the  penalty  of  a 
prohibition  on  common  stock  dividends,  it  is 
sometimes  provided  that  the  exclusive  voting 
power  shall  vest  in  the  preferred  stock-holders, 
who  are  placed  in  control  of  the  company  until 
the  provisions  of  the  contract  have  been  com- 
plied with.  These  restrictions  are  excellent. 
They  are  calculated  to  secure  the  investor.  They 
cannot,  however,  impart  to  preferred  stock  the 
security  of  a  mortgage  bond,  secured  not  only  by 

235 


THE  CAREFUL  INVESTOR 

earnings  but  by  properties  specifically  set  aside 
for  its  protection. 

Even  with  all  these  safeguards  and  restrictions, 
preferred  stock  ranks  after  all  forms  of  indebted- 
ness. Its  dividends  are  payable  only  when  earned, 
and  then  at  the  discretion  of  the  directors.  It 
ranks  ahead  of  common  stock,  it  is  true,  but  dur- 
ing periods  of  depression,  or  in  case  the  directors 
pursue  an  unwise  policy,  involving  the  company 
in  financial  embarrassment,  the  holders  of  the 
preferred  stock  must  be  prepared  to  stand  the 
loss.  They  must  recognize  that  they  are  not 
creditors  of  the  company,  but  merely  owners; 
that  in  any  final  adjustment  or  liquidation  of  the 
company's  affairs  the  creditors'  claims  must  first 
be  satisfied,  and  the  preferred  stock-holders  must 
take  what  is  left. 

A  melancholy  example  of  misfortune  of  this 
character  is  furnished  by  the  fate  of  the  McCrum- 
Howell  Company,  a  corporation  engaged  in  the 
manufacture  of  radiators,  boilers,  and  enameled 
ware,  which  in  1910  made  a  large  issue  of  pre- 
ferred stock  for  the  purpose  of  acquiring  control 
of  companies  manufacturing  vacuum-cleaners  and 
other  appliances. 

I  have  before  me  the  circular  issued  by  the 
236 


INDUSTRIAL  PREFERRED  STOCK 

fiscal  agents  under  date  of  November  i,  1910, 
and  containing  a  variety  of  information  which 
was  then  believed  to  be  accurate,  but  which  sub- 
sequent events  proved  was  not  correct.  The 
assets  of  the  company  amounted  to  $7,425,685, 
according  to  this  statement.  Against  these  assets, 
there  was  no  debt.  The  liabilities  included 
$3,500,000  of  common  stock  and  an  equal  amount 
of  cumulative  preferred  stock,  a  surplus  of  $333,- 
185  and  a  reserve  of  $92,500.  The  charter  of  the 
company  provided  that  no  bonds  could  be  placed 
upon  the  property  of  the  company  except  with 
the  consent  of  the  total  outstanding  stock.  The 
proceeds  from  the  sale  of  this  preferred  stock 
increased  the  net  working  capital  of  the  company 
to  $2,408,597,  which,  it  was  stated,  "provides 
the  company  with  ample  working  capital  to  care 
for  its  increasing  business."  The  accounts  of 
the  several  companies,  it  is  stated  on  the  authority 
of  "chartered  accountants,"  show  net  earnings  of 
$640,195,  over  two  and  one-half  times  the  divi- 
dend requirements  on  the  entire  issue  of  preferred 
stock.  Dividends  of  3  per  cent,  were  being  paid 
on  the  common  stock.  As  a  result  of  the  consoli- 
dation, large  increases  in  earnings  were  expected. 
One  of  the  banker's  circulars  concluded  as  follows : 
237 


THE  CAREFUL  INVESTOR 

From  the  standpoint  of  security,  stability  of  earnings,  liberal 
income  return,  marketability,  and  promise  of  appreciation  in 
value,  we  regard  the  above  stock  as  a  safe  and  attractive  invest- 
ment. Our  recommendation  is  based  on  our  own  intimate  knowl- 
edge of  the  affairs  of  the  company  for  the  past  five  years. 

This  issue  was  offered  by  a  number  of  banking 
houses  to  their  clients.  It  is  presumed  that  they 
made  proper  investigations  into  the  affairs  of  the 
various  companies,  and  that  they  had  confidence 
in  the  merits  of  the  scheme.  Certainly  the  issue, 
although  not  as  good  as  some  others,  was,  on  the 
face  of  these  statements,  of  a  very  good  quality. 
The  new  company  had  no  debts.  Its  earnings 
were  equal  to  two  and  one-half  times  the  pre- 
ferred dividend  requirements.  With  a  prospect 
of  large  increases  in  those  earnings,  the  investor 
could  be  reasonably  certain  that  his  preferred 
dividends  would  be  regularly  paid,  or  that,  in  case 
it  proved  necessary  to  suspend  these  dividends,  he 
would  risk  nothing  more  than  a  postponement  of 
his  income.    This  was  on  November  i,  1910. 

Sixteen  months  later  we  find  the  following 
news  item: 

Justice  Buffington,  in  the  United  States  District  Court  at 
Philadelphia,  appointed  Edward  R.  Stettinius,  President  of  the 
Diamond  Match  Co.,  and  Walter  D.  Updegraff,  of  Philadelphia, 
receivers,  on  application  of  A.  F.  Pfahler  of  Philadelphia,  who, 
it  is  said,  owns  1310,300  stock.     The  company  agreed  to  the 

238 


INDUSTRIAL  PREFERRED  STOCK 

receivership,  but  declared  that  inabiHty  to  realize  on  assets,  and 
not  insolvency,  was  the  cause  of  its  troubles. 

The  bill  alleges  that  the  company  is  perfectly  solvent,  but 
that  a  reorganization  is  necessary;  that  the  company  has  suffered 
extremely  in  the  last  six  months  from  a  sudden  contraction  in 
trade,  due  in  great  measure  to  the  Government's  suit  against  the 
"bathtub  trust,"  which  also  hurt  the  company's  credit.  There 
is  said  to  be  outstanding  about  $1,800,000  in  commercial  paper 
in  the  hands  of  many  parties,  maturing  within  the  next  four 
months,  of  which  $300,000  matures  before  March  3 1 ,  and  ' '  quick  " 
assets  in  excess  of  commercial  paper  which  cannot  be  turned  into 
money  to  meet  obligations.  The  liabilities  are  stated  to  aggregate 
$2,1 18,000,  and  the  quick  assets  $1,749,000,  consisting  of  accounts 
receivable,  $1,480,000;  bills  receivable,  $219,000,  and  cash, 
$50,000. 

On  September  27  th  we  have  another  news 
item — the  report  of  the  receivers.  In  place  of 
temporary  embarrassment,  we  now  find  revealed 
a  condition  of  absolute  bankruptcy.  Mr.  Albert 
H.  Wiggin,  Chairman  of  the  Creditors'  Commit- 
tee, says  in  substance:  "Our  investigations  have 
convinced  us  that  if  the  property  be  disposed  of 
at  a  forced  sale,  the  creditors  can  realize  but  a 
small  percentage  of  their  claims.  The  business, 
however,  appears  to  have  an  earning  power.  Mr. 
Strong  estimates  the  earnings,  after  making  cer- 
tain improvements,  at  $209,000  a  year,  with  a 
gradual  increase.     Others  name  higher  figures." 

The  receivers  presented  at  this  time  a  statement 
of  assets,  in  place  of  the  $7,425,685  set  forth  in 

239 


THE  CAREFUL  INVESTOR 

the  letter  of  the  president  of  the  company,  "sub- 
mitted and  verified  by  the  Safeguard  Account 
Company,  Chartered  Public  Accountants,"  to 
the  amount  of  $2,179,361,  a  shrinkage  of  $5,200,000 
in  two  years  and  three  months.  The  liabilities 
of  the  company,  which  were  so  clear  and  clean 
two  years  before,  now  present  a  melancholy 
spectacle.  They  include  accounts  payable,  $326,- 
647;  bills  payable,  $2,047,053;  endorsed  or  guar- 
anteed paper,  $212,693;  a  total  of  $2,586,394. 
And  in  addition  there  were  over  $700,000  of 
improved  claims.  The  receivers  further  say: 
"The  company  originally  manufactured  boilers, 
radiators,  enameled  bath-tubs,  lavatories,  etc., 
but  early  in  19 10  adopted  a  policy  of  expansion, 
to  which  its  embarrassment  is  largely  attributable. 
None  of  these  purchases  proved  profitable;  the 
portable  vacuum-cleaner  business  resulted  in 
heavy  losses." 

One  last  news  item  completes  the  story. 

Justice  Buffington  in  the  United  States  District  Court  in 
Philadelphia,  on  November  13,  19 12,  affirmed  the  sale  of  the 
assets  and  property  of  the  company,  to  a  committee  representing 
the  creditors,  for  $870,000  cash.  The  offer  was  made  two  weeks 
ago,  over  80  per  cent,  of  the  creditors  having  consented  thereto. 
The  reorganization  will  be  effected  at  once. 

I  do  not  claim  that  this  disaster  which  elimi- 

240 


INDUSTRIAL  PREFERRED  STOCK 

nated  $3,500,000  of  preferred  stock,  into  which 
large  investors  had  put  their  money,  and  de- 
stroyed a  large  common  stock  equity,  is  typical 
of  what  will  befall  other  industrial  corporations 
which  have  put  out  their  securities  on  the  strength 
of  banker's  recommendations  and  seven  per  cent, 
dividends.  This  case  is,  no  doubt,  exceptional. 
It  does,  however,  show  how  quickly  the  aspect 
of  prosperity  may  be  changed  by  unwise  financial 
management,  and  especially  by  a  rapid  increase 
in  debt.  The  preferred  stock-holder  is  powerless 
to  prevent  such  a  catastrophe.  Even  though  his 
contract  with  the  company  prohibits  the  directors 
from  issuing  any  evidences  of  debt  maturing  in 
more  than  one  year,  they  cannot  be  restricted  in 
making  bank  loans  or  in  buying  merchandise 
on  account. 

I  have  before  me  a  list  compiled  by  a  large 
financial  institution,  of  the  notes  and  paper  of 
various  industrial  corporations  outstanding  at 
various  dates  in  191 1  and  191 2.  The  totals  in 
some  cases  are  very  large  and  are  rapidly  increas- 
ing. These  floating  debts  represent  a  constant 
menace  to  the  solvency  of  these  companies.  They 
carry  a  threat  of  receivership  and  foreclosure  sale 
which  the  stockholder  cannot  disregard.     When 

16  241 


THE  CAREFUL  INVESTOR 

the  directors,  therefore,  propose  an  issue  of  bonds 
or  notes  to  fund  these  floating  debts,  the  stock- 
holders can  do  nothing  less  than  to  consent. 
To  refuse  their  consent  is  to  invite  disaster. 
What,  then,  becomes  of  this  much  vaimted  re- 
striction as  to  note  issues  and  mortgages?  It  is 
valueless  in  the  face  of  such  a  situation. 

A  large  corporation,  with  a  record  of  over  sixty 
years  of  continuous  growth,  a  little  more  than  a 
year  ago  issued  $8,000,000  of  preferred  stock, 
with  the  usual  restrictions  for  the  protection  of 
the  preferred  stock-holders.  The  total  accounts 
and  bills  payable  of  this  company  were,  in  round 
numbers,  $2,700,000,  with  a  surplus  of  assets  over 
current  liabilities  of  nearly  $19,000,000.  A  few 
months  later  this  company  announced  a  large 
issue  of  notes  for  the  purpose  of  refunding  its 
floating  debt.  These  notes  come  ahead  of  the 
preferred  stock,  and  there  is  no  way  in  which 
the  holders  of  the  preferred  stock  can  prevent 
their  issue. 

I  would  not  be  understood  to  condemn  indus- 
trial preferred  stocks.  They  should  be  character- 
ized as  speculative  investments.  Most  of  them 
will,  no  doubt,  continue  to  pay  regular  dividends. 
But   such   securities    should   be   purchased   only 

242 


INDUSTRIAL  PREFERRED  STOCK 

from  the  most  reliable  banking  houses,  who  will 
stand  back  of  the  issue,  and  who  will  not  hesi- 
tate to  use  their  great  power  as  fiscal  agents  of 
the  company  to  prevent  unwise  and  extravagant 
management,  and  the  departure  from  lines  of 
policy  whose  wisdom  has  been  proven  by  the 
experience  of  long  success.  The  purchaser  of 
such  stocks  must  also  realize  that  he  is  taking  a 
risk;  that  seven  per  cent,  is  not  compatible  with 
an  assurance  of  absolute  safety,  and  that  in  the 
event  of  a  recurrence  of  industrial  depression  he 
must  be  prepared  to  submit  to  a  postponement 
of  his  dividends. 


XXI 

THE   DISSOLUTION   OF  THE   TRUSTS 

Judgment  day  for  the  trusts  has  arrived.  Some 
of  them,  we  hope,  are  good,  and  some  of  them  are 
evil.  The  federal  courts  are  now,  and  will  be  for 
a  long  time,  occupied  in  separating  the  sheep 
from  the  goats.  The  Supreme  Court,  in  the  Oil 
and  Tobacco  cases,  has  set  up  a  standard  by 
which  to  decide  which  of  these  great  companies 
is  lawful,  and  which  must  be  dissolved. 

The  opinion  of  the  court  is  clear  that  any  cor- 
poration engaged  in  interstate  commerce  (which 
includes  all  the  trusts),  and  which  has  been  formed 
not  "with  the  legitimate  purpose  of  reasonably 
forwarding  personal  interest  and  developing  trade, 
but  on  the  contrary  were  of  such  a  character  as  to 
give  rise  to  the  inference  or  presumption  that  they 
had  been  entered  into  or  done  with  the  intent  to  do 
wrong  to  the  general  pubHc,  and  to  limit  the  right 
of  individuals,  thus  restraining  the  free  flow  of 
commerce,  and  tending  to  bring  about  the  evils 
such  as  enhancement  of  prices  which  were  con- 

244 


THE  DISSOLUTION  OF  THE  TRUSTS 

sidered  to  be  against  public  policy,"  is  unlawful 
under  the  Sherman  Act. 

The  court  says,  in  effect,  that  any  large  com- 
pany or  collection  of  companies,  formed  with 
the  purpose  of  limiting  competition,  that  is  ad- 
vancing or  keeping  up  prices,  or  which,  after  its 
promotion,  uses  its  power  to  limit  competition, 
so  that  prices  can  be  advanced,  is  an  unlawful 
organization  and  must  be  dissolved.  In  the  light 
of  these  decisions  the  legal  position  of  the  large 
companies  formed  in  the  last  twenty  years,  to 
put  together  sometimes  thirty  smaller  concerns 
which  had  been  competing  with  one  another,  is 
very  doubtful.  Most  people  who  own  securities 
of  any  kind  have  the  preferred  or  common  stocks 
of  these  industrials.  There  are  large  companies, 
all  organized  on  the  model  of  the  Standard  Oil 
Company,  whose  stock  prices  appear  in  the  daily 
New  York  quotations.  If  the  movement  against 
the  trusts  continues,  all  these  hundreds  of  thou- 
sands of  stock-holders — the  Steel  Trust  alone  has 
over  100,000 — must  adjust  themselves  to  new  con- 
ditions. Until  this  adjustment  is  made,  or  so  long 
as  the  fear  of  it  is  present,  what  we  call  prosperity 
will  not  return. 

How  will  this  adjustment  be  made?  How  can 
245 


THE  CAREFUL  INVESTOR 

the  trusts  be  dissolved,  in  such  a  manner  as  the 
court  says,  "to  protect,  not  to  destroy,  rights  of 
property?"  A  word  about  the  organization  of  the 
trusts.  Here  are  five  corporations,  A,  B,  C,  D, 
and  E,  making  shoes,  or  steel,  or  pumps,  or 
harvesting  machinery.  These  companies  are 
competitors;  they  are  constantly  fighting  one 
another — raiding  one  another's  customers;  cut- 
ting prices,  secretly  and  sometimes  openly;  mak- 
ing agreements,  gentlemen's  agreements,  and  then 
breaking  them ;  stealing  or  corrupting  one  another's 
employees;  biting  and  clawing  each  other  in  the 
bear-pit  of  competition;  behaving  like  mediaeval 
captains  of  brigands  instead  of  modem  captains 
of  industry.  The  men  who  control  these  com- 
panies decide  to  combine  and  so  stop  the  waste 
of  competition. 

Suppose,  for  the  sake  of  simplicity,  the  stock 
of  each  of  these  five  companies  is  $2,000,000,  each 
share  having  a  face  value  of  $100.  A  New  Jersey 
corporation  is  organized,  which  issues  $20,000,000 
of  stock — $10,000,000  preferred  and  $10,000,000 
common.  The  preferred  stock  is  entitled  to 
receive  $700,000,  seven  per  cent.,  before  anything 
is  paid  on  the  common.  The  consolidation  is 
now  formed  by  the  exchange  of  one  share  of  pre- 

246 


THE  DISSOLUTION  OF  THE  TRUSTS 

ferred  stock  and  one  share  of  common  stock  of 
the  New  Jersey  corporation  for  each  of  the  100,000 
shares  of  the  five  companies.  The  New  Jersey- 
company — let  us  call  it  the  Amalgamated  Com- 
pany— now  owns  $10,000,000  of  the  five  companies 
and  their  former  stock-holders  own  $10,000,000 
of  the  preferred  and  common  stocks,  $2.00  for 
$1.00  of  the  stock  of  the  five  companies — an 
operation  familiar  to  most  people  as  stock  watering. 
Immediately  price-cutting,  misrepresentation, 
slander,  back-biting,  everything  that  goes  under 
the  name  of  cut-throat  competition,  is  at  an  end 
between  them.  The  Amalgamated  Company  is 
the  sole  owner  of  all  five,  electing  directors,  choos- 
ing officers,  establishing  prices,  driving  these  five 
tamed  animals  to  one  vehicle  and  in  one  set  of 
harness.  Every  feature  of  the  business  policy  is 
now  reduced  to  rule  and  order.  The  territory 
over  which,  as  competitors,  all  were  accustomed 
to  raid  and  foray,  is  divided  among  them.  One 
of  the  five  plants  may  be  out  of  date,  badly  located. 
Its  business  is  divided  among  the  other  four.  The 
general  administration  is  centred  in  New  York; 
financing,  buying,  advertising  supervision,  all  are 
managed  from  a  central  office.  In  place  of  war, 
concord,  peace,  and  harmony  succeed  within  the 

247 


THE  CAREFUL  INVESTOR 

circle  of  these  former  rivals.  The  new  company 
may  not  advance  prices,  but  it  gets  from  the 
customer  those  prices  which  it  publishes;  every 
one  pays  the  same  prices.  There  are  no  rebates, 
no  special  discounts,  no  allowances. 

This,  in  brief,  is  the  change  which  was  accom- 
plished by  the  organization  of  the  trusts.  There 
is  a  darker  side  to  the  picture.  Stories  and  sworn 
statements  of  the  wrongful  and  oppressive  use 
of  the  great  power  of  these  great  corporations  are 
numerous.  Business,  however,  is  not  conducted 
to  the  strains  of  soft  melody.  At  best,  some  of 
its  practices  are  not  pretty.  Probably  the  two 
culprits  did  no  more,  nor  as  much,  against  the 
moral  law,  when  their  enormous  size  is  considered, 
than  the  average  grocer  or  milkman.  In  passing, 
it  may  be  observed  that  in  the  grocery  trade,  to 
quote  but  one  instance,  there  are  three  prices  for 
the  same  coffee  done  up  in  different  packages. 

The  Supreme  Court  did  not,  however,  heed 
these  charges.  It  passed  them  over.  To  arrive 
at  the  conclusion  that  the  Standard  Oil  and  the 
American  Tobacco  Companies  should  be  dis- 
solved, it  was  not  necessary  to  inquire  whether 
these  companies  were  benevolent  despotisms. 
That  they  were,  or  aimed  to  be,  supreme  in  their 

248 


THE  DISSOLUTION  OF  THE  TRUSTS 

respective  fields,  was  sufficient  to  condemn  them, 
and  to  condemn  any  other  company  which  by  the 
consolidation  of  competitors  has  reached  a  posi- 
tion similarly  exalted. 

Since  the  Standard  Oil  Trust  has  passed  out 
of  existence,  a  word  in  its  favor  may  be  more 
favorably  received  than  when  it  was  alive.  De 
tnortuis  nihil  nisi  bonum. 

One  of  the  undisclosed  abuses  in  the  railway 
industry  is  the  open  violation  by  many  shippers 
of  the  classification  rules  of  the  railroads.  There 
are  five  classifications  into  which  falls  every  com- 
modity save  such  as  are  carried  on  special  rates, 
like  coal  and  lumber.  The  rates  are  highest  on 
Class  I,  and  fall  to  Class  V.  The  basis  of  dis- 
tinction between  these  classes  is  the  cost  or  risk 
to  the  railroad  in  shipping  them,  together,  in 
some  cases,  with  the  value  of  the  article.  An 
article  which  is  carefully  boxed  or  crated  wiil 
take  a  Class  III  rate,  while  if  it  is  not  protected 
from  breakage,  it  will  take  a  Class  II  rate. 

There  was  a  liveryman  in  an  Iowa  town  who 
needed  a  carload  of  horses.  Emigrant  movables, 
including  furniture  and  live  stock,  take  a  very 
low  rate.  The  railroads  seek  to  encourage  settle- 
ment.    Horses  take  a  high  rate.     Our  friend  was 

249 


THE  CAREFUL  INVESTOR 

familiar  with  these  facts.  He  went  to  Montana, 
bought  his  horses,  loaded  with  them  into  a  car 
two  kitchen-chairs,  an  old  stove,  and  some 
domestic  bric-d-brac,  and  billed  the  whole  as 
"household  movables."  Another  enterprising 
shipper  also  billed  the  following  articles  as  house- 
hold movables:  portable  forge,  2  sinks,  i  bundle 
rakes,  i  wire  gate,  6  loose  sledges,  i  barrel  lan- 
terns, 2  wheelbarrows,  i  box  pipe-fittings,  200 
reels  of  barb  wire.  These  cases  are  not  excep- 
tional. More  than  a  thousand  are  reported  daily 
in  New  York  City  alone.  Each  offense  is  punish- 
able by  fine  or  imprisonment,  or  both,  at  the 
discretion  of  the  court. 

To  detect  these  misdescriptions,  the  railroads 
maintain  inspection  bureaus,  whose  inspectors 
are  constantly  on  the  alert  to  raise  the  freight  on 
way-bills  incorrectly  made  out.  Nothing  else  is 
done.  Until  recently  the  Interstate  Commerce 
Commission  has  not  been  willing  to  act  in  the 
matter.  Why  should  the  railroads  concern  them- 
selves with  the  enforcement  of  the  law.  Chicago  is 
one  of  the  centres  of  misdescription.  The  inspectors 
are  constantly  on  the  watch  to  detect  violations 
of  the  law  and  to  raise  the  rates.  The  list  of 
habitual   offenders   is   long,    and   contains   some 

250 


THE  DISSOLUTION  OF  THE  TRUSTS 

honored  names;  but  the  name  of  the  Standard 
Oil  Company  of  Indiana  is  not  among  them.  An 
ofhcial  of  one  of  the  inspection  bureaus  told  me 
that  in  a  service  of  thirteen  years  not  one  of  his 
inspectors  had  ever  reported  even  a  minor  infrac- 
tion of  the  rules  by  the  Standard  Oil  Company. 
Let  us  consider  another  instance  of  a  different 
kind.  When  a  man  or  a  corporation  has  some- 
thing to  sell,  he  or  it  can  usually  be  relied  upon 
to  put  a  high  value  upon  it.  Sometimes,  even 
when  the  sellers  are  very  conservative,  the  value 
is  excessive.  A  large  public-service  company, 
owning  plants  in  many  cities,  recently  arranged 
to  purchase  a  gas  company  owned  by  the  Stand- 
ard Oil  Company  interests,  and  managed  ac- 
cording to  Standard  Oil  methods.  In  the  schedule 
of  assets  submitted  for  the  consideration  of  the 
buyers  appeared  this  item,  "Securities  owned, 
$200,000."  The  president  of  the  purchasing  com- 
pany pounced  instantly  upon  this.  He  became 
suspicious.  He  resolved  to  investigate.  He  had 
experience  with  "Securities  owned."  He  knew 
how  worthless  they  might  be.  He  asked  the 
vendor's  attorney  for  a  list  of  these  "securities." 
The  attorney  said,  "They  are  all  bonds."  "Bonds 
of  what?"     "United  States  Government  Bonds," 

251 


THE  CAREFUL  INVESTOR 

was  the  answer.  The  gas  company  had  put  aside 
a  large  amount  out  of  its  earnings  in  the  safest 
securities  in  the  world. 

These  old-fashioned  business  virtues  of  strict 
obedience  to  the  laws  cf  business,  caution  in  pay- 
ing out  profits,  prompt  payment  of  bills,  accurate 
accounting  and  bookkeeping,  avoidance  of  debt, 
fair  and  honorable  treatment  of  employees,  main- 
tenance of  high  standards  of  product — virtues  for 
which  the  Standard  Oil  Company  has  always  been 
distinguished — are,  of  course,  not  to  be  weighed 
in  the  balance  against  "the  intent  and  purpose 
to  maintain  the  dominion  over  the  oil  industry"; 
but  they  are  at  least  not  so  common  even  among 
the  critics  of  the  company  as  to  pass  unnoticed. 
Indeed,  the  possession  and  recent  practice  of 
these  virtues  by  certain  men  prominent  in  the 
magazine  field  would  have  saved  them  control 
of  their  properties  which  have  passed  into  other 
hands.  Let  us  hope  that  with  the  breaking  up 
of  the  Standard  Oil  Company  there  will  be  a 
general  diffusion  of  certain  of  its  principles  and 
business  methods  in  quarters  which  now  know 
ihem  not. 

These  trusts,  by  the  mandate  of  the  court,  are 
now  being  dissolved.    The  method  which  has  been 

252 


THE  DISSOLUTION  OF  THE  TRUSTS 

followed  in  each  dissolution  is  to  distribute  the 
assets  of  the  New  Jersey  companies  among  their 
stockholders.  Take  the  case  assumed  above,  for 
example.  The  Amalgamated  Company  has  issued 
100,000  shares  of  preferred  and  100,000  shares 
of  common  stock.  It  has  in  its  treasury  100,000 
shares  of  the  stocks  of  the  five  companies.  On 
these  stocks  it  has  been  collecting  dividends  and 
paying  out  these  dividends  to  its  own  stock- 
holders. The  court  now  orders  this  company  to 
dissolve.  It  adopts  the  method,  so  called,  of  a 
pro  rata  distribution  of  assets.  Each  of  the  five 
companies  changes  its  charter  so  as  to  turn  50,000 
shares  of  common  stock  into  50,000  shares  of 
preferred  stock,  still  in  the  hands  of  the  New 
Jersey  company,  the  Amalgamated,  the  sole 
owner  of  all  the  shares.  Then  for  each  share  of 
its  preferred  stock  the  Amalgamated  gives  one- 
fifth  share  of  the  preferred  stocks  of  each  of  the 
five  companies,  and  for  each  share  of  its  common 
stock  it  gives  one-fifth  share  of  common  stock  in 
each  of  the  five  companies.  The  Amalgamated 
Company  can  now  be  dissolved.  Its  stock- 
holders have  all  of  its  assets.  For  all  practical 
purposes,  it  has  ceased  to  be.  The  five  original 
companies    remain,    but    now,    instead    of    their 

253 


THE  CAREFUL  INVESTOR 

owTiership  and  control  being  in  the  hands  of  the 
Amalgamated  Company,  they  are  owned,  it  may 
be,  by  i,ooo  individuals  holding  from  5  to  1000 
shares  each.  This  method  with  some  variations 
has  been  applied  to  dissolve  the  Oil  Trust,  the 
Tobacco  Trust,  the  Powder  Trust,  and  all  the 
rest  of  the  condemned. 

Now  comes  the  rub.  Cut- throat  competition 
is  bad.  This  is  generally  recognized.  Mr.  Andrew 
Carnegie  was  the  last  apostle  of  the  old  com- 
petitive regime,  and  he  passed  out  of  business  ten 
years  ago.  For  several  years  Mr.  Elbert  H.  Gary 
has  been  conducting  a  school  of  cooperation  for 
iron  and  steel  products.  His  classes  have  been 
largely  attended,  and  the  lectures  have  been  both 
interesting  and  instructive.  At  the  last  session 
of  the  class  in  cooperation,  held  at  the  Waldorf- 
Astoria  on  May  29,  191 1,  Judge  Gary  summed 
up  the  objects  and  results  of  the  course  as  follows : 

Whatever  we  do  with  reference  to  prices,  whatever  we  may 
decide  is  necessary  in  order  to  protect  our  interests  on  this  occa- 
sion and  under  these  circumstances,  in  my  opinion  it  is  highly 
important  for  the  long  future  that  we  continue  our  relations  of 
friendship  and  open  and  frank  expression  with  reference  to  what 
we  are  doing.  Now,  I  do  not  know  the  feeling  of  the  rest  of  you. 
I  do  not  know  what  you  are  disposed  to  do.  I  think  that  so  far 
as  we  are  concerned  we  would  be  largely  influenced  by  the  action 
of  others,  and  while  insisting  upon  the  position  from  which  I 

254 


THE  DISSOLUTION  OF  THE  TRUSTS 

have  never  varied,  I  would  not,  under  any  circumstances,  make 
any  agreement,  eM}ressed  or  implied,  direct  or  indirect,  to  main- 
tain certain  prices,  to  keep  away  from  customers,  to  divide  terri- 
tory, to  restrict  output,  or  to  make  any  agreement  of  any  sort 
or  description  with  you  or  any  of  you,  because,  as  I  understand 
the  law,  I  have  no  right  to  do  it;  yet  at  the  same  time  I  would 
do  what  I  have  always  said  I  would  do;  I  would  tell  you  and 
each  of  you  at  any  time  exactly  what  we  are  doing;  I  would  give 
you  the  names  of  our  customers;  I  would  tell  you  what  prices 
we  were  charging;  I  would  give  you  any  information  concerning 
our  business,  concerning  our  mills,  concerning  our  clients,  con- 
cerning ourselves,  that  you  wanted'to  have,  so  long  as  you  have 
the  same  disposition  toward  me. 

Competition  should  relate  to  standards  of  prod- 
uct, to  promptness  of  delivery,  to  service,  and 
should  not  refer  to  price.  Railroads  compete 
furiously  for  passenger  business,  yet  they  do  not 
cut  rates.  They  merely  increase  the  speed  and 
comfort  of  their  trains.  Price-cutting  in  any 
trade  quickly  leads  to  demoralization.  It  destroys 
confidence,  makes  cooperation  impossible,  leads  to 
deterioration  in  quality,  and  makes  business  uncer- 
tain and  hazardous.     Again,  quoting  Judge  Gary : 

There  is  only  a  certain  amount  of  business.  You  can  get  it 
away  from  your  friend  for  a  day  or  a  week ;  perhaps  you  can  make 
a  contract  for  a  time  and  get  a  particular  order;  but  in  the  long 
run,  on  the  average,  month  by  month,  year  by  year,  you  cannot 
get  and  keep  his  business. 

Granting  the  evils  of  competition  in  prices, 
and   the   superiority   of   cooperative   methods  in 

255 


THE  CAREFUL  INVESTOR 

business,  the  fact  remains  that  the  temptation  to 
cut  prices  in  dull  times  in  order  to  get  business 
from  competitors  is  almost  irresistible.  The 
buyer,  taking  naturally  and  without  effort  the 
role  of  Satan,  shows  the  seller  a  promised  land 
of  profitable  contracts,  new  business,  future  con- 
nections, if  only  the  seller  will  cut  the  price. 
Times  are  hard,  business  is  slow,  debts  are  press- 
ing. It  is  almost  too  much  to  expect  of  a  man  of 
small  calibre  that  he  shall  set  his  face  like  a  flint 
against  the  blandishments  and  alluring  induce- 
ments of  the  buyer.  And  yet,  if  he  yields,  the 
evil  spirit  of  price-competition,  accompanied  by 
seven  other  devils,  will  return  to  the  house  from 
which  the  trust  movement  expelled  him,  and  the 
last  state  of  American  business  will  be  worse 
than  the  first. 

Here  lies  the  danger  to  the  prosperity  of  the 
United  States  in  the  dissolution  of  the  trusts. 
Broken  up,  as  they  will  be,  into  a  thousand  small 
companies,  strictly  forbidden  to  combine,  each  with 
its  separate  officers,  its  own  board  of  directors,  can 
ruinous  competition  be  prevented?  Will  these 
directors  and  officers  be  big  enough  to  adhere  to 
the  prices  published  by  the  leaders  in  the  trade, 

and,  so  far  as  the  law  allows,  wiU  they  cooperate 

256 


THE  DISSOLUTION  OF  THE  TRUSTS 

for  mutual  benefit  by  disclosing  to  one  another 
their  lists  of  customers  and  the  terms  on  which 
they  do  business?  If  the  American  business  man 
can  rise  to  the  emergency  presented  by  the  dis- 
solution of  the  trusts,  the  decisions  will  prove  to 
have  been  of  great  benefit. 

For  there  is  another  side  to  the  trust  picture, 
a  side  which  is  by  no  means  attractive.  Large 
aggregations  of  widely  scattered  plants,  managed 
by  hired  men,  supervised  by  directors  who  repre- 
sent thousands  of  stock-holders  with  no  other 
interest  in  the  industry  than  to  get  their  divi- 
dends, cannot  be  managed  with  the  same  energy, 
efficiency,  and  economy  as  smaller  industrial 
imits  can  be  handled.  The  cost  of  production  of 
the  trusts,  speaking  broadly,  is  far  above  the  cost 
of  the  best  plants  which  went  into  the  trusts, 
although  it  is  lower  than  that  of  the  poorest 
plants.  An  intelligent,  energetic  group  of  partners 
or  stock-holders,  with  ample  capital,  operating 
a  single  plant,  can  produce  at  lower  cost  than  can 
a  large  and  scattered  aggregation  of  plants  man- 
aged by  hired  men,  no  matter  how  intelligent 
and  conscientious. 

In  conversation  recently  upon  the  subject  of 
centralized  management,  a  well  known  engineer 
17  257 


THE  CAREFUL  INVESTOR 

cited  his  own  experience  in  managing  a  group  of 
public-service  corporations  from  a  New  York 
office.  Daily  reports  were  forwarded  to  him  from 
each  company,  and  he  was  in  instant  touch  with 
every  emergency.  He  found,  however,  after  a 
series  of  costly  experiments,  that  the  plan  would 
not  work.  Mistakes  would  occur  which  he  would 
correct,  but  the  mistakes  could  not  be  antici- 
pated or  the  resulting  losses  prevented.  He  was 
eventually  compelled  to  abandon  the  system  of 
centralized  management,  and  place  each  company 
upon  its  own  footing,  with  its  own  responsible 
head. 

In  so  far  as  the  trusts  are  concerned,  it  is  a 
simple  matter  to  prove  that  these  "economies 
of  combination"  are  largely  imaginary.  It  will 
be  recalled  that,  in  organizing  our  hypothetical 
combination,  preferred  stock  in  the  Amalgamated 
Company  was  given  share  for  share  to  the  stock- 
holders of  the  five  companies  that  went  into  the 
combination,  and  also  an  equal  amount  of  com- 
mon stock.  This  common  stock,  in  most  cases, 
was  "water";  that  is  to  say,  it  did  not  represent 
any  value  in  existence.  It  was  supposed  to  repre- 
sent the  "economies  of  combination."     Each  of 

the  five  plants  was  worth  $2,000,000  before  the 

258 


THE  DISSOLUTION  OF  THE  TRUSTS 

trust  was  formed.  By  putting  them  together, 
destroying  competition  among  them,  reducing 
imnecessary  expenses,  and  with  the  advantages 
of  high-grade  management,  this  value,  it  was 
assiuned,  would  be  increased  to  $4,000,000,  or 
the  value  of  the  five  from  $10,000,000  to  $20,000,- 
000.    This  plan  was  followed  in  nearly  every  case. 

Now,  if  we  wish  to  discover  the  value  and  extent 
of  these  "economies,"  it  is  only  necessary  to  look 
at  the  quotations  of  these  common  stocks.  Most 
of  the  trusts  have  been  in  existence  eight  years  or 
more,  and  the  period  of  their  life  includes  some 
of  the  most  profitable  years  in  the  history  of 
American  industry.  They  have  had  plenty  of 
time  to  realize  these  economies.  If  there  is  a 
basis  for  the  organization  of  consolidations  of 
nimierous  plants,  managed  by  a  board  of  directors 
in  New  York,  the  common  stocks,  which  repre- 
sent the  "economies  of  combination" — the  sav- 
ings from  buying  in  large  quantities,  the  lower 
rates  of  interest  paid  to  the  banks,  the  superior 
talents  of  high  salaried  men,  along  with  the 
admitted  gains  from  stable  prices — would  appear 
in  high  dividends  and  high  prices  for  the  stocks. 

And  yet  we  find  such  quotations  as  these, 
representing  the  percentage  of  $100  per  share, 

259 


THE  CAREFUL  INVESTOR 

at  which  the  trust  common  stocks  are  now  selling : 
Allis  Chalmers,  9K;  American  Beet  Sugar,  39^; 
American  Agricultural  Chemical,  46;  American 
Can  S%',  American  Car  and  Foundry  50^;  Ameri- 
can Locomotive,  35^;  and  so  on.  There  are  a  few 
exceptions,  but  for  the  most  part,  so  far  as  the 
market  quotations  of  the  trust  stocks  are  con- 
cerned, the  "economies  of  combination"  do  not 
exist.  It  is  possible  that  the  United  States  has 
paid  too  high  a  price  in  an  industrial  development 
arrested  by  the  stagnant  routine  of  monopoly 
for  the  benefits  of  suppressed  competition. 


XXII 
THE  INVESTOR  AND  GOLD  SUPPLY 

In  a  series  of  articles  recently  published  in 
Cotton  and  Finance,  dealing  with  the  subject  of 
gold  production  and  its  effect  upon  the  prices  of 
bonds,  stocks,  and  commodities,  Mr.  Theodore 
H.  Price  reaches  a  conclusion  which,  if  it  can  be 
established,  is  of  vital  moment  to  every  owner  of 
property  in  the  United  States,  whether  that 
property  be  bonds,  insurance  policies,  stocks,  or 
real  estate.  This  conclusion,  briefly  stated,  is 
that  the  increasing  production  of  gold  is  respon- 
sible for  the  great  rise  of  prices  which  has  been 
the  characteristic  feature  of  the  last  decade;  that 
this  increased  production  of  gold  will  continue 
indefinitely;  and  that  the  world  is  facing  an 
economic  crisis  arising  out  of  the  certainty  of  a 
persistent  depreciation  in  its  standard  of  value. 

This  subject  has  been  much  discussed  in  recent 
years,  as  the  steady  rise  of  prices  has  brought 
home  to  every  class  in  the  community  the  im- 
portance of  the  problem  presented.     The  fact  of 

the  advance  of  prices  is  well  established.    In  1896 

261 


THE  CAREFUL  INVESTOR 

Bradstreet's  compilation  of  the  wholesale  prices 
of  1 06  commodities,  including  all  the  leading 
commodities  of  commerce,  was  59,124.  In  1900, 
this  figure  had  risen  to  78,839;  in  1905,  to  80,987; 
and  in  191 2,  to  90,362.  Specimen  increases  in 
particular  commodities  are  even  more  striking. 
For  example,  the  price  of  wheat,  during  this 
period  of  seventeen  years,  rose  from  64  cents  to 
$1.22 ;  the  price  of  com,  from  33  cents  to  86  cents; 
the  price, of  beef  cattle,  from  4.6  cents  to  9  cents; 
eggs,  from  12  cents  to  20  cents;  raw  cotton  from 
7  cents  to  II  cents;  anthracite  coal  from  $4.25 
to  $5.50;  and  so  on,  with  hardly  any  exception, 
throughout  the  entire  list.  This  rise  of  prices  is 
mainly  responsible  for  the  high  cost  of  living. 
The  advance  of  prices  is  lessening  the  purchasing 
power  of  gold  over  the  necessaries  of  life. 

The  competition  of  corporations  for  the  money 
of  the  investor,  on  the  other  hand,  because  of  the 
rapid  multiplication  of  companies,  and  the  numer- 
ous safeguards  which  its  experience  and  informa- 
tion is  teaching  the  bankers  to  throw  about  the 
stocks  and  bonds  which  they  offer  for  sale,  is 
growing  constantly  sharper,  and  is  forcing  down 
the  prices  of  all  securities  which  carry  a  fixed 

income,  and  which  have  no  prospect  of  sharing 

262 


THE  INVESTOR  AND  GOLD  SUPPLY 

in  increasing  profits.  The  investment  fund,  it  is 
true,  is  steadily  increasing,  but  since  the  pur- 
chasing power  of  a  4  per  cent,  or  5  per  cent, 
investment  income  is  so  rapidly  declining,  while, 
at  the  same  time,  the  number  of  securities  offering 
these  rates  of  interest  is  increasing,  the  natural 
result  is  that  the  investor  discriminates  against 
so-called  "gilt-edge"  bonds.  This  depreciation 
in  the  prices  of  bonds,  while  apparently  it  is  an 
advantage  to  investors  making  new  purchases,  is 
threatening  heavy  losses  to  the  owners  of  invest- 
ments already  in  existence. 

Few  realize  to  what  an  enormous  total  the 
securities  of  bonds  and  stocks  issued  by  American 
corporations  has  mounted.  In  an  article  by 
Francis  Lynde  Stetson,  pubHshed  in  the  Atlantic 
Monthly  for  July,  1912,  which  is  quoted  by  Mr. 
Price,  the  following  statement  is  made : 

In  the  fiscal  year  1909,  according  to  the  report  of  the  Commis- 
sioner of  Internal  Revenue,  there  were  in  the  United  States 
262,490  corporations  of  all  kinds,  with  more  than  $84,000,000,000 
of  stocks  and  bonds,  and  $3,125,000,000  of  income,  paying  a 
Federal  tax  of  about  $27,000,000.  For  the  fiscal  year  1910-11 
the  figures  had  risen  to  270,000  corporations,  with  more  than 
$88,000,000,000  of  stock  and  bonds,  and  $3,360,000,000  of 
income,  paying  a  federal  tax  of  $29,432,000.  As  the  total  wealth 
of  the  United  States  has  been  estimated  at  $125,000,000,000,  it 
would  appear  that  nearly  two-thirds  of  it  is  held  by  corporations. 

263 


THE  CAREFUL  INVESTOR 

Approximately  one-third  of  this  immense  mass 
of  securities  represents  promises  to  pay  gold  at 
various  dates  in  the  future,  and  the  value  of  the 
commodity  which  these  bonds  promise  to  pay  is 
falling  with  every  advance  in  the  average  price 
of  other  commodities.  Standard  railroad  bonds 
which,  fifteen  years  ago,  were  selling  on  a  3>^  per 
cent,  basis,  have  now  fallen  in  price  until  they 
yield  between  4%  ^"d  4^  per  cent.,  and  their 
decline  is  persistent.  During  the  past  year,  the 
decline  in  the  prices  of  all  kinds  of  bonds  has  been 
noteworthy.  Every  variety  of  bonds — railroad, 
industrial,  municipal — has  suffered  from  the  de- 
preciation of  investments. 

On  the  other  hand,  this  same  period  which  has 
witnessed  such  a  marked  decline  in  the  value  of 
bonds  has  shown  an  even  more  pronounced  ad- 
vance in  the  prices  of  stocks.  The  average  price 
of  36  standard  railroad  and  industrial  stocks  in 
1896  was  $62.50;  in  May,  191 2,  this  average 
price  had  almost  doubled,  rising  to  $118.  The 
reason  is  as  follows:  A  share  of  stock  represents 
a  right  to  participate  in  the  distribution  of  profits 
of  the  corporation.  These  profits  tend  to  increase 
during  periods  of  rising  prices,  because  the  costs 
of  production  and  distribution,  including  a  large 

284 


THE  INVESTOR  AND  GOLD  SUPPLY 

amount  of  fixed  expense,  as,  for  example,  interest, 
depreciation,  etc.,  do  not  advance  to  correspond 
with  the  increase  in  the  selling  value  of  the  prod- 
uct. Every  business  which  depends  upon  the  sale 
of  a  commodity  has  felt  the  stimulating  influence 
of  rising  prices.  Even  the  public-service  corpora- 
tions, whose  prices  and  rates  are  fixed  by  law  and 
custom — the  railroads,  street-railways,  gas,  elec- 
tric light,  and  water  companies — have  profited 
enormously  from  the  immense  business  which  the 
advance  of  prices  has  so  greatly  assisted  to  pro- 
duce. It  is  no  wonder,  therefore,  that  the  prices 
of  the  stocks  which  promised  their  holders  partici- 
pation in  this  recent  flood  of  industrial  profits 
should  have  scored  such  rapid  advances. 

Here,  then,  is  the  situation.  The  advance  of 
prices  shows  no  sign  of  stopping.  With  every 
increase  in  commodity  prices,  the  purchasing  power 
of  gold  declines.  Every  form  of  corporate  debt, 
every  variety  of  bonds,  is  a  promise  to  pay  this  com- 
modity which  is  so  rapidly  depreciating  in  value. 
Of  necessity,  therefore,  prices  of  bonds  decline  as 
the  prices  of  commodities  advance.  On  the  other 
hand,  risingpricesmeanrisingprofits,  and  the  prices 
of  stocks  which  participate  in  those  rising  profits 
advance  far  more  rapidly  than  bonds  decline. 

265 


THE  CAREFUL  INVESTOR 

The  conclusion  is  inevitable,  and  Mr.  Price  has 
no  hesitation  in  emphasizing  it  in  the  strongest 
possible  terms.  If  the  advance  of  prices  is  to  con- 
tinue, the  investor  should  discriminate  against  all 
bonds,  mortgages,  and  notes  which  are  simply 
contracts  to  deliver  at  a  future  date  so  many- 
grains  of  gold,  since  the  purchasing  power  of  that 
gold  is  constantly  diminishing,  and  should  prefer 
agricultural,  timber,  and  mineral  lands,  and  cor- 
poration stocks.  In  other  words,  if  the  deprecia- 
tion of  gold  is  to  continue,  the  prices  of  bonds 
must  persistently  depreciate.  Any  one  buying  a 
security  carrying  a  fixed  income,  whether  a  bond 
or  a  preferred  or  guaranteed  stock,  must  face  the 
probability  of  a  fall  in  the  price  of  his  investment. 
On  the  other  hand,  those  who  put  their  money 
into  property  or  certificates  of  interest  in  corpora- 
tions which  give  them  the  right  to  participate  in 
the  profits  of  industry,  can  look  forward  to  a 
steady  appreciation  in  the  money  value  of  their 
investments. 

These  statements  challenge  attention.     I  have 

stated  them  in  the  baldest  possible  manner,  so 

that  the  issues  which  they  raise  can  be  set  forth 

with  entire  distinctness.     If  the  depreciation  of 

gold    continues,    bonds    must    come    down    and 

266 


THE  INVESTOR  AND  GOLD  SUPPLY 

stocks  must  rise.  If  a  survey  of  the  situation 
shall  lead  us  to  the  conclusion  that  the  deprecia- 
tion of  gold  will  at  no  distant  date  work  its  own 
remedy  in  arresting  the  increase  in  the  produc- 
tion of  gold,  then  these  pessimistic  utterances 
can  be  subject  to  the  moderating  influence  of  a 
heavy  discount. 


XXIII 
PRICE  MOVEMENTS  SINCE  1865 

In  the  previous  chapter  we  reviewed  the  pessi- 
mistic conclusions  expressed  by  Mr.  Theodore  H. 
Price  concerning  the  future  of  bond  prices.  These 
conclusions  are,  in  effect,  that  the  prices  of  fixed 
interest  bonds  will  continue  to  decline,  while  the 
prices  of  commodities  and  land  will  continue  to 
advance,  and  they  are  based  upon  the  assumption 
that  the  supply  of  gold  will  continue  to  increase 
for  an  indefinite  period. 

In  order  to  see  what  basis  there  is  for  this 
conclusion,  it  is  necessary  to  examine  into  the 
history  of  gold  production  and  prices.  This  is 
not  the  first  experience  the  world  has  had  with 
high  prices.  In  fact,  the  prices  of  191 1,  measured 
by  the  quotations  of  forty  years  ago,  are  extremely 
moderate.  The  highest  prices  ever  reached  since 
accurate  records  have  been  kept  were  in  1873, 
when  the  average  of  45  staple  articles  of  com- 
merce stood  at  III  per  cent,  of  the  average  from 
1867  to  1877,  which  was  taken  as  the  standard. 

From  this  point,  during  the  next  twenty  years, 

268 


PRICE  MOVEMENTS 

prices  rapidly  declined,  until  in  1896,  when  the 
lowest  point  was  reached,  they  stood  at  only 
61  per  cent,  of  the  standard,  a  decline  of  50  points 
in  twenty-three  years. 

This  fall  of  prices  was  primarily  due  to  a  marked 
falling-off  in  the  production  of  gold,  which  began 
in  1865,  and  continued  imtil  the  lowest  point  was 
reached  in  1883.  While  the  output  of  gold  mines 
was  declining,  industry  and  trade  continued  to 
advance,  and  the  result  was  a  very  large  increase 
in  the  demand  for  gold  falHng  upon  a  stationary 
or  declining  supply.  Prices,  therefore,  suffered 
the  serious  decline  already  indicated.  This  fall 
of  prices  coincided  with  a  series  of  disastrous 
commercial  panics,  followed  by  periods  of  long 
depression,  in  which  bankruptcies  were  nimierous, 
the  number  of  imemployed  large,  prices  decHning, 
and  trade  stagnant  and  depressed.  During  this 
period,  the  question  of  the  fall  of  prices  agitated 
the  world  even  more  than  the  difficulties  con- 
nected with  the  rise  of  prices  perplex  it  to-day. 
Here  and  there  a  man  of  intelligence  was  found 
to  express  the  opinion  that  the  fall  of  prices  was 
a  benefit,  but  the  consensus  of  opinion  was  that 
it  was  an  unmitigated  evil. 

Writing  in  the  Journal  of  the  Royal  Statistical 
269 


THE  CAREFUL  INVESTOR 

Society  for  September,  1886,  Mr.  Augustus  Sauer- 
beck, who  has  long  enjoyed  the  reputation  of  the 
world's  greatest  price-statistician,  summed  up  the 
situation  as  follows: 

A  decline  of  prices,  so  far  as  occasioned  by  a  reduction  in  the 
cost  of  production,  is  a  decided  advantage  for  the  consumer,  as 
his  principle  will  always  be,  "the  cheaper  the  better."  The 
lower  classes  have  therefore  improved  their  position,  as  wages 
have  only  moderately  fallen,  while  they  can  buy  most  of  their 
requirements  at  lower  prices.  Altogether,  they  are  much  better 
off  than  in  the  first  half  of  the  century,  and  what  was  formerly 
considered  a  luxury  forms  now  part  of  their  daily  wants. 

If  we,  however,  say  "the  cheaper  the  better,"  we  must  not 
forget  that  "cheap"  is  a  relative  expression,  and  cannot  mean 
"the  lower  the  better."  If  all  prices,  or  the  prices  of  most  of 
the  principal  articles,  fall,  then  it  is  a  distinct  disadvantage  to 
all  producing  classes;  they  either  lose  heavily  or  have  their 
profits  curtailed.  Capital  is  reduced,  or  does  not  increase  at  the 
usual  ratio,  and  ultimately  the  loss  to  the  whole  community 
must  be  much  greater  than  any  small  advantage  to  the  consumer. 

A  real  benefit  is  only  derived  by  the  classes  with  fixed  incomes, 
and  by  capitalists  possessing  consols  and  similar  safe  investments, 
who  can  buy  more  commodities  with  their  income.  Many,  how- 
ever, had  their  interests  reduced  by  one  per  cent.,  and  their 
income,  therefore,  say,  by  20  to  25  per  cent.    .    .    . 

Producers  have  been  the  severest  sufferers,  and  particularly 
those  of  agricultural  produce,  who  had  to  sustain  the  strong 
competition  of  cheap  soil  in  extra-European  countries,  which 
became  more  eflfective  by  the  reduction  of  freight  and  charges. 
The  consequence  was  a  general  decline  in  the  value  of  land.  ,  .   . 

The  ultimate  range  cf  prices  is,  on  the  whole,  immaterial,  as 
it  is  not  prices,  but  quantities,  which  keep  people  employed;  but 
it  is  not  at  all  immaterial  how  prices  move,  and  every  strong 
decline  is  accompanied  by  a  severe  crisis.    The  income  is  reduced, 

270 


PRICE  MOVEMENTS 

and  people  find  it  difficult  or  impossible  to  retrench,  particularly 
if  luxury  has  increased  during  a  period  of  great  prosperity.  It 
is  the  period  of  transition  under  which  we  suffer,  and  when  this 
is  passed  we  may  again  expect  better  times. 

The  better  times  which  Mr.  Sauerbeck  pre- 
dicted did  not  arrive  for  ten  years  after  the  article 
from  which  the  above  quotation  was  taken  ap- 
peared. The  depression  which  he  portrayed  in 
such  moderate  terms  continued  to  spread,  with 
only  occasional  respites,  caused  by  bountiful 
crops  or  some  similar  temporary  relief,  until  1896. 

Contrary  to  the  belief  generally  held,  that  the 
investor  profited  by  this  decline  of  prices  and  the 
resulting  depression,  the  reverse  was  the  case. 
The  investor  suffered  quite  as  severely  as  any 
other  class.  As  prices  declined,  the  profits  of 
industry  diminished,  and  the  margin  of  security 
which  is  found,  not  in  the  case  of  productive 
property,  but  in  its  profitableness,  rapidly  dimin- 
ished. At  intervals,  as  a  result  of  this  decline  in 
profits,  came  wholesale  outbreaks  of  bankruptcy, 
in  which  the  soundest  and  strongest  corporations 
were  carried  down  to  ruin,  inflicting  enormous 
losses  upon  investors.  Bond-holders  and  stock- 
holders alike  were  involved  in  this  catastrophe. 
This  was  the  period  which  saw  the  bankruptcy 

271 


THE  CAREFUL  INVESTOR 

of  the  Union  Pacific,  the  Northern  Pacific,  the 
Reading,  and  the  Atchison,  Topeka  and  Santa  Fe. 
Ten  years  before  their  failures,  which  followed  the 
panic  of  1893,  four  of  these  five  railroads  were 
ranked  among  the  strong  railroad  enterprises  of 
the  country.  Their  failures  aflected  bond-holders 
and  stock-holders  alike. 

The  security  of  bonds  was  weakened  by  the 
decline  of  prices,  and  the  investor  found  slight 
compensation  in  the  advance  of  the  prices  of  those 
of  his  holdings  which  survived  the  shock  for  the 
impairment  of  his  security.  At  the  same  time, 
when  he  came  to  invest  his  surplus  income  in  any 
security,  the  number  of  staple  investments,  owing 
to  the  persistence  of  depression  and  bankruptcy, 
was  so  much  reduced  as  to  carry  the  piices  of 
strong  investments  to  figures  at  which  they 
yielded  between  3  and  3>^  per  cent,  on  the  pur- 
chase price.  It  is  a  mistaken  notion  that  the 
investor  profits  during  periods  of  falling  prices. 
He  suffers  in  common  with  the  rest  of  the  com- 
munity. Falling  prices,  due  to  a  scarcity  of  gold, 
are  an  evil.  A  downward  movement  of  prices 
blights  enterprises,  discourages  producers,  and 
injures  the  investor  in  hardly  less  degree. 

It  is  from   this  industrial   slough   of  despond 

272 


PRICE  MOVEMENTS 

that  the  large  increase  in  gold-production,  which 
began  in  1886,  and  has  continued  until  the  last 
few  years,  has  rescued  the  civilized  world.  The 
past  ten  years  have  been  years  of  world-wide 
and  abounding  prosperity,  in  which  every  class 
has  participated.  It  is  true  that  real  wages — 
that  is,  the  purchasing  power  of  money  wages 
over  the  necessaries  of  life — have  declined,  but, 
on  the  other  hand,  the  aggregate  of  wages  re- 
ceived, owing  to  the  abundant  opportunities  for 
employment,  has  been  far  greater  than  it  was 
during  the  low-priced  years  which  preceded.  The 
producing  classes  have  everywhere  prospered. 
The  value  of  land  has  greatly  advanced,  and  the 
farmer  in  every  country  in  the  world  has  estab- 
lished his  financial  position  on  a  basis  of  prosperity. 
The  investors  have  also  profited.  In  so  far  as 
they  held  stocks,  they  have  seen  these  stocks  rise 
to  high  figures.  If  they  held  mortgages,  they 
have  had  these  mortgages  promptly  paid,  in  strik- 
ing contrast  to  the  frequent  necessity  of  fore- 
closure which  characterized  the  years  following 
the  panic  of  1893.  If  the  security  of  their  bonds 
had  been  impaired  by  the  previous  years  of  de- 
pression, the  years  of  prosperity  have  repaired  the 
damage  done,  and  elevated  to  the  class  of  sound 

18  273 


THE  CAREFUL  INVESTOR 

investments  a  very  large  number  of  railroad  and 
industrial  investments,  whose  previous  reputation 
had  been  bad.  The  rise  of  prices,  and  the  spread 
and  permanence  of  industrial  prosperity,  have  also 
brought  before  the  investor  large  numbers  of 
issues,  as,  for  example,  timber  bonds  and  mining 
bonds,  which,  during  periods  of  depression,  it 
would  not  be  safe  for  him  to  touch.  These  new 
securities,  together  with  the  large  and  growing 
class  of  public  utility  bonds,  offer  him  rates  of 
income  far  greater  than  those  which  were  open  to 
him  in  safe  investments  twenty  years  ago.  If  the 
investor  has  suffered  in  the  depreciation  of  high- 
grade  securities  in  recent  years,  he  has  obtained 
compensation  several  times  over  in  increased  op- 
portunities for  investment  at  higher  rates  of  inter- 
est and  the  increased  security  of  his  holdings. 


XXIV 
INVESTOR  AND  THE  FUTURE  OF  PRICES 

Every  one  who  discusses  the  price  question 
takes  it  for  granted  that  prices  will  continue  to 
advance,  borne  up  on  a  constantly  rising  money- 
supply.  As  the  prices  of  commodities  go  up,  the 
prices  of  bonds,  and  all  other  forms  of  fixed  interest 
investment  will  decline.  The  purchasing  power 
of  salaries,  rents,  etc.,  will  fall,  the  assets  of  large 
investment  institutions  will  be  depleted,  and  the 
investing  class,  generally,  will  suffer  severe  losses. 
On  the  other  hand,  it  is  urged  that  the  advance 
in  prices  of  commodities  will  put  up  the  prices  of 
stocks,  and  all  forms  of  property  except  loans, 
rental  investments,  or  annuities.  The  conclusion 
drawn  from  this  prediction  is  that  the  investor 
should  discriminate  against  bonds  and  in  favor  of 
stocks  and  real  property. 

If,  however,  it  appears  upon  examination  that 
there  is  no  warrant  for  believing  that  the  supply 
of  gold  will  continue  to  increase  as  it  has  in  the 
past;  if  we  reach  the  conclusion  that  the  gold 
supply  will  advance  much  less  rapidly  in  the  next 

275 


THE  CAREFUL  INVESTOR 

two  decades  than  it  has  in  the  past,  it  is  safe  to 
predict  that  prices  will  not  go  much  higher. 

Before  taking  up  the  question  of  the  future 
supply  of  gold,  let  us  look  for  a  moment  at  the 
other  side  of  the  price  ratio.  A  large  part  of  the 
advance  in  commodity  prices  has  been  due  to  the 
pressure  of  population  upon  the  means  of  sus- 
tenance. In  1890,  thirty-six  out  of  ever>^  hundred 
inhabitants  of  the  United  States  lived  in  cities 
and  towns  of  more  than  2,500  inhabitants.  In 
1 9 10,  the  percentage  of  city  and  town  dwellers 
had  increased  to  forty-six.  The  population  of  the 
cities  during  this  twenty-year  period  rose  from 
22,700,000  to  46,600,000,  while  the  population  of 
the  farms  rose  from  40,237,000  to  49,348,000. 
This  is  a  gain  of  20,000,000  people  for  the  towns, 
and  9,000,000  for  the  farms.  In  other  words, 
the  consumptive  demand  for  food-products  is 
increasing  much  more  rapidly  than  the  number 
of  people  available  to  produce  the  food. 

An  examination  of  the  yield  of  our  principal 

cereal  crops  confirms  this  conclusion.     In   1889 

there  was  a  record  corn-crop  in  the  United  States, 

and    the    total    production    reached    2.1    billion 

bushels.     By  191 1  the  production  had  risen  only 

to  2.5  billion  bushels.    The  yield  per  acre  in  1889 

276 


INVESTOR  AND  FUTURE  PRICES 

was  27  bushels,  and  in  191 1  about  24  bushels. 
The  wheat-yield  of  the  United  States  in  1889  was 
490,000,000  bushels,  and  in  191 1,  621,000,000 
bushels.  The  yield  per  acre  was  almost  the  same, 
12.9  bushels  in  1889  and  12.5  bushels  in  191 1. 

The  statistics  of  farm  animals  make  even  a 
more  disastrous  showing.  In  1890  there  were 
57,648,000  cattle  on  American  farms;  in  191 1  the 
number  had  increased  only  to  60,502,000,  al- 
though the  total  population  of  the  country  during 
the  same  period  had  risen  from  62,947,000  to 
91,972,000.  The  showing  for  hogs  is  but  little 
better:  50,625,000  in  1890,  and  65,620,000  in  191 1. 

These  few  comparisons  prove  conclusively  that 
one  cause  of  the  advance  of  prices  has  been  the 
diminishing  yield  from  the  farms,  at  a  time  when 
the  demand  for  food-stuffs  was  greatly  increased 
by  the  growth  in  city  population.  It  is  unreason- 
able to  suppose  that  this  condition  will  be  allowed 
long  to  continue.  Farming  is,  at  the  present  time, 
the  most  profitable  American  industry,  and  yet 
American  farms,  if  cultivated  with  intelligence 
and  with  sufficient  capital,  could  easily  double 
their  yield.  It  is  a  poor  farm  that  cannot  show 
50  bushels  of  com  to  the  acre,  and  yet  the  average 

for  the  United  States  is  less  than  24  bushels.     A 

277 


THE  CAREFUL  INVESTOR 

yield  of  20  bushels  of  wheat  to  the  acre,  with 
ordinary  cultivation  and  care,  is  not  excessive. 
The  average  yield  for  the  United  States,  however, 
is  only  12.  Yields  of  oats  from  50  to  60  bushels 
to  the  acre  are  very  commonly  secured  by  intelli- 
gent and  competent  farmers.  The  average  yield 
for  the  United  States  is  only  24.4  bushels. 

The  widespread  agitation  of  this  subject  of 
rising  prices  of  farm-lands,  and  the  growing 
interest  of  all  classes  in  the  problem  of  food-supply, 
is  certain  to  result  in  a  very  great  increase  in  the 
production  of  agricultural  products  during  the 
next  decade,  and  it  is  a  reasonable  presumption 
that  farm  products  will  be  lower  as  a  result. 
While  the  yield  from  farms  already  in  cultivation 
will  increase,  enormous  areas  of  new  land  are 
being  opened  up.  The  completion  of  the  Grand 
Trunk  Pacific  in  Canada  is  certain  to  make  large 
additions  to  the  wheat  supply.  The  agricultural 
area  of  the  Argentine  Republic  is  rapidly  ex- 
panding, stimulated  by  the  enormous  profits  to 
be  gained  from  wheat-growing.  Agriculture,  the 
world  over,  is  feeling  the  stimulus  of  high  prices 
and  immense  profits.  The  natural  consequence 
will  be  a  continued  increase  in  the  supply  of  food- 
stuffs, and  fall  in  their  prices. 

278 


INVESTOR  AND  FUTURE  PRICES 

Space  does  not  permit  a  review  of  the  corre- 
sponding developments  in  other  lines  of  raw- 
material  production.  It  is  sufficient  to  point  out 
that  the  production  of  coal,  iron,  wool,  cotton, 
copper,  and,  indeed,  all  of  the  materials  of  in- 
dustry, is  advancing  rapidly,  and  that  the  tendency 
everywhere  seems  to  be  toward  lower  prices  as 
a  result. 

What  now  of  the  gold  supply?  Are  we  war- 
ranted in  believing  that  the  supply  of  gold  will 
continue  to  increase,  and  that  its  value  will  pro- 
gressively decline?  It  is  impossible,  on  the  basis 
of  an  examination  of  the  history  of  gold-produc- 
tion, to  reach  such  a  conclusion.  On  the  con- 
trary, the  indications  are  abundant  that  gold- 
production  for  the  next  few  years  has  nearly,  if 
not  quite,  reached  its  maximum,  and  that  the 
production  will  continue  to  decline. 

Gold  has  a  fixed  price — $20.67  ^^  ounce.  The 
gold-miner  is  producing  money.  Out  of  his  daily 
production,  he  must  pay  his  expenses.  He  buys 
labor,  timber,  drill  steel,  candles,  lubricating  oil, 
quicksilver,  wood,  sulphuric  acid,  salt,  scrap  iron, 
and  rope,  in  addition  to  large  amounts  of  machin- 
ery. He  also  hires  a  variety  of  skilled  labor, 
besides    many    unskilled    workmen.      The    lower 

279 


THE  CAREFUL  INVESTOR 

the  prices  of  these  materials  and  the  lower  the 
wages  of  labor,  the  larger  will  be  the  margin  which 
remains  out  of  his  daily  production  of  money. 

When  prices  fall,  and  when  labor  is  cheap  and 
abimdant,  this  margin  is  large.  As  a  result,  the 
gold-miner  makes  large  profits;  investors  are 
anxious  to  put  their  money  in  his  business. 
Prospectors  are  active  in  discovering  new  deposits. 
The  annual  production  is  extended  to  ores  yield- 
ing, in  some  cases,  less  than  $3.00  a  ton.  A  large 
increase  in  the  output  of  gold  is  the  result.  When 
prices  are  rising,  however,  the  margin  of  the  gold- 
miner's  profits  is  reduced.  The  rising  prices, 
which  increase  the  profits  of  other  industries, 
compel  him  to  pay  more  for  his  labor.  The 
investor's  money  is  directed  into  other  channels 
than  gold-mining.  The  prospecting  activities,  no 
longer  stimulated  by  lack  of  opportunity  for 
employment,  on  the  one  hand,  and  by  the  glit- 
tering prizes  of  discovery  on  the  other,  slacken. 
The  gold-miner  is  forced  to  abandon  the  immense 
bodies  of  low-yield  ore.  As  a  result,  gold-pro- 
duction declines. 

This  movement  is  at  present  taking  place  in 
every  gold-mining  country.  Those  who  are 
counting  on  an  increase  in  the  production  of  gold 

280 


INVESTOR  AND  FUTURE  PRICES 

should  examine  the  statistics  of  gold-production 
in  the  United  States.  The  principal  gold-mining 
States  are  Alaska,  California,  Colorado,  Mon- 
tana, Nevada,  South  Dakota,  and  Utah.  Of 
these  seven  States,  only  one  shows  any  large 
increase  in  gold  production,  the  State  of  Nevada, 
due  to  the  development  of  a  few  camps  of  extra- 
ordinary richness.  The  production  in  Alaska, 
which  was  $18,000,000  in  1907,  in  191 1  was  only 
$16,000,000.  Colorado  in  1905  produced  $25,000,- 
000  of  gold;  in  191 1  only  $19,000,000.  The  pro- 
duction of  Montana,  during  the  same  period,  fell 
from  $5,000,000  to  a  little  more  than  $3,000,000. 
South  Dakota  about  held  its  own.  The  produc- 
tion of  Utah  seriously  declined.  The  production 
of  Nevada,  during  the  same  period,  rose  from 
$5,000,000  to  $19,000,000,  and  the  production 
for  the  United  States  increased  from  $88,000,000 
to  $96,000,000,  an  increase  due  to  the  phenomenal 
discoveries  in  a  single  State. 

These  figures  show  that  the  gold-mining  indus- 
try, taking  the  Western  country  as  a  whole,  is 
declining,  the  natural  inference  from  the  extra- 
ordinary prosperity  in  competing  industries 
throughout  this  section.     Even  taking  the  figures 

for  the  entire  world,  there  is  no  reason  to  anti- 

281 


THE  CAREFUL  INVESTOR 

cipate  a  continuance  of  the  rate  of  increase.  In 
1906  the  total  production  of  the  world  was  $402,- 
000,000.  Five  years  later  it  was  $455,000,000. 
These  annual  increases  in  production,  it  must 
be  remembered,  are  added  to  a  stock  of  gold 
which  has  now  reached  immense  proportions,  so 
that  the  percentage  of  increase  is  small.  It  must 
also  be  remembered  that  the  demands  for  money 
are  rapidly  increasing — ^increasing,  indeed,  far 
more  rapidly  than  a  gain  of  ten  or  fifteen  million 
dollars  a  year  can  satisfy.  Take,  for  example, 
the  national  banks  of  the  United  States,  In  1900 
these  banks  held  in  specie  $373,000,000,  nearly 
all  of  this  being  gold.  In  191 1,  twelve  years 
later,  the  specie  holdings  had  increased  to  $711,- 
000,000,  more  than  double  the  former  amount. 

Every  time  a  new  bank  is  organized,  and  the 
number  is  rapidly  increasing,  a  certain  amount 
of  money  must  be  withdrawn  from  circulation 
and  put  into  that  bank's  reserve.  This  represents 
an  increasing  demand  upon  the  world's  money 
supply.  What  is  going  on  in  the  United  States 
is  but  typical  of  development  in  other  countries. 
Canada  and  South  America  are  rapidly  enlarging 
their  banking  reserves.  Immense  amounts  of 
gold  will  be  sent  to  China  to  assist  in  the  industrial 

282 


INVESTOR  AND  FUTURE  PRICES 

development  of  that  country.  The  final  settle- 
ment of  the  Turkish  problem  will  open  the  re- 
sources of  the  Balkan  Peninsula  to  exploitation, 
and  large  amounts  of  money  will  be  required  to 
carry  on  this  new  business.  In  every  part  of  the 
world,  in  vast  regions,  until  recent  years  un- 
touched by  civilization,  railroads  are  being  con- 
structed, mines  opened,  farms  developed,  and 
money — that  is,  gold — required. 

In  view  of  the  small  increases  in  the  annual 
production  of  gold,  and  in  view  also  of  the  cer- 
tainty that  the  next  decade  will  see  large  increases 
in  the  production  of  commodities  and  in  the 
demand  for  money,  it  is  imreasonable  to  expect 
that  prices  will  much  longer  continue  to  increase. 
The  investor  who  has  been  discouraged  by  a 
decline  in  the  prices  of  his  fixed  interest  securities, 
and  who  has  been  tempted  to  sell  them  out  at  a 
sacrifice,  or  to  exchange  them  for  bonds  of  less 
merit,  but  higher  yield,  will  do  well  to  remember 
that  economic  history  always  repeats;  that  there 
have  been  periods  of  rising  prices  in  the  past, 
and  that  these  have  always  been  followed  by  other 
periods  when  prices  were  declining  and  bonds 
increasing  in  value. 


283 


INDEX 


Accurate  predictiona  difficult,  29 
Agriculture,  need  of  investment  in, 

200 
American  Railway  Securities,  115 
equipment,  117 
expenditures,  116 
explanation  of  decreasing  output, 

116 
freedom  from  competition,  122 
Pennsylvania  Railroad  compared 
with  U.  S.  Steel  Corp.,  120,  121 
profits,  118,  119 
size  of  plant  and  personnel,  117 
stability   of   demand   for   service, 
122 
American  Sugar  Refining  Co.,  42 
Analysis  of  issuing  company,  68,  69 
Anthracite  strike,  1902,  211 
Argentine    Republic,    expanding    in 

agricultural  area,  278 
Ashley,  Michigan,  invalid  issue,  103 
Atchison,  Topeka  &  Santa  Fe,  14, 
16,  17 
bankruptcy,  272 
Audit  of  corporation  books,  69 
example,  86,  158,  159 

Bad  investment  losses,  37 
Baltimore  &  Ohio,  bankruptcy,  212 

profits,  138 
Bank  examiners,  19 
Bankruptcies,  Atchison,  Topeka  & 
Santa  Fe,  272 

Baltimore  &  Ohio,  212 

Eastern  Railroad  Co.,  illustration, 
22 

Lombard  Investment  Co.,  201 

McCrum-Howell  Co.,  230-240 

Northern  Pacific,  272 

Reading  Ry.,  272 

Union  Pacific,  272 


Board  of  Directors,  42 

Board  of  Supervising  Engineers,  109 

Bondholders,  rights  of,  59 

superior  position  of,  45-47 
Bond  house,  work  of,  49 
Bonds,  definition,  38 

of  going  concerns,  39 

how  to  buy,  48 

in  default,  46 

invalid  issues,  103 

stability  of  prices,  47 
Bond  values,  decline,  264-266 
Bradstreet's   compilation   of   wholj- 
sale  prices,  106 

commodities,  262 
Breach  of  trust,  18 
Brokerage  houses,  inspection  of,  19 
Buffalo,  Rochester  &  Eastern  R.  R., 

example,  181,  182 
Burke,  Edmund,  98 
Byllesby,  H.  M.,  66 

Capital  stock  increasing,  43 
Carnegie,  Andrew,  254 
Centralized  management,  258 
Cereal  crops,  yield,  276 
Chamberlain,  Lawrence,  106 
Chewing  gum,  illustration,  24 
Ctiicago  Railways  Co.,  illustration, 

167,  168 
China,  industrial  development  of,  282 
Choice  of  securities,  36 
Clive,  Lord,  129 
Commissions,  14,  26 
Commodity  prices,  262,  276 
Competition,  122,  212,  213 

e\'ils  of,  254-256 
Consolidated    Gaa    Co.    of    N.    Y., 

opinion,  148,  150 
Constitution    of    U.     S.,    eleventh 

amendment,  93 


285 


INDEX 


Construction  si'ndicates,  68 
Consumptive    demand,     increasing, 

276 
Convertible  debentures,  illustration, 

32 
Cooperative  buying,  77 

methods,  254,  255 
Corporate  deed  of  trust,  form,  54 
Corporation  bondholder,  40,  52 
Corporation  mortgage,  covenants,  56 

default,  58 
Cost  of  living  problem,  199 
Cost  of  production,  257 
Crop  failures,  31 
Curtice,  Mr.  Justice,  95 
Cut-throat  competition,  254 

Dean,  Maurice  B.,  103 

Defaults,  remedy,  113 

Demand  greater  than  population,  146 

Depreciation  in  bond  prices,  263 

in  public  service  issues,  159 
Depression  in  United  States,  1908, 43 
Direct  offering,  155 
Direct  ownership  of  bonds,  48 

objections  to,  48 
Dissolution  of  Standard  Oil  Co.,  252, 

253 
Dividend  paying  stocks,  24 
Dividends,  42 

Eastern  Railroad  Co.,  bankruptcy, 

illustration,  22 
Economies  of  combination,  258-260 
Election  of  directors,  41,  42 
Eleventh  amendment  of   Constitu- 
tion of  U.  S.,  93 
Engineers'  investigations,  63-66,  68, 
157 

Farm  animals,  statistics,  277 
lands,  rising  prices,  278 
mortgage,  advantages,  of,  185 
definition,  185 
disadvantages,  188,  189 
increase  in  values,  198 


Farm  mortgage,   method  of  making, 
192-201 
mortgage  broker,    work   of,    illus- 
tration, 191,  192,  201,  202 
provisions,  187 
value  of  farm    property,    United 

States,  197 
yields,  diminishing,  278 
Farms  as  a  basis  of  investment,  197 
number  and  acreage  in  U.  S.,  198 
Faulty  investigation,  63-66,  88 
Floating  debts,  241,  242 
Fluctuations  in  stocks,  47 
Food  products,  consumptive  demand 

increasing,  276 
Franchises,  bankruptcy,  166 

Chicago  Railways  Co.,  illus.,  107, 

168 
Board  of  Supervising  Engineers, 

169 
excessive  capitalization,  164 
New  York  city,  illustration,   171 
obligations  of  public,  175 
Philadelphia  transit  problem,  170- 

174 
prices  reduced,  165 
public  sentiment,  166 
rights  of  public,  175 
taxes  laid,  165 
Fundamental  conditions,  27 
crops,  27 
earnings,  27 
interest  rates,  27 

Gambling,  profitableness  of,  26 
Gary,  Elbert  H.,  254,  255 
Gas  industry.  New  York,  147 
Gilt-edge  bonds,  263 
Gold,  fixed  price,  279 

margin  of  profit,  278,  280 
miner,  profits  of,  280 

new  discoveries,  280 
mining  statistics  (U.  S.),  281 
industry  declining,  281 
world's  production,  282 


286 


INDEX 


Gold  production — Bradstreet's  com- 
pilation, 262 
effect  upon  prices,  201,  268,  269 
falling  off  in  production,  269 
increase  in  production,  273 

Grand  Trunk  Pacific  in  Canada,  278 

Grant  in  Trust  clause,  54 

Great      Northern      and      Northern 
Pacific,  152 

Habendum  clause,  54 
Havemeyer,  Henry  O.,  42 
Hill,  James  J.,  200 

Income  of  American  people,  36 
Increase  in  railway  expenses,  124 
Impending     shortage     of     railway 

equipment,  124 
Industrial  bonds,  206 

caution  in  purchasing,  206 

classification,  206 

compared  with  railroad  bonds,  207 

security  of,  206 
Induatrial    corporations,    notes   and 

paper  outstanding,  241 
Industrial  preferred  stocks,  233 

effect  of  unwise  financial  manage- 
ment, 241 

investigations,  233 

McCrum-Howell  Co.  failure,  236- 
240 

rank  after  all  forms  of  indebted- 
ness, 236 

restrictions  and  aafeguajtis,   235, 
236 

speculative  investments,  242,  243 
Industrial  prosperity,  273,  274 

trust  movement,  232 
Inspection  of  brokerage  houaea,  19 
Instalment      plan      of      purchasing 
stocks,  34,  35 

illustration,  35 
Insurance  companies' in  vestments,  49 
Interstate    Commerce   Commission, 
134,  135 

rate  advances,  124-129,  141 


Interstate   Commerce  Commission, 
"Reasonable  return,"  136 
Trunk  line  petition,  134,  135 

Invalid  bond  issues,  103 

Investigation  methods,  67 
faulty,  63,  88 

Investment   banker,   advantages  of 
dealing  with,  75 
advantages  of  association  in  same 

line  of  trade,  76 
cooperative  buj-ing,  77 
expensive  operations  of,  74 
guaranty,  85 
losses  and  defaults,  83 
protection  of  customers,  87-90 
quality  of  bonds  offered,  80-82 
record  of  flotations,  91 
safety  of  bonds  purchased  from,  84 
superior  advantages,  77,  78 
use  of  credit,  76 
work  of,  61-66. 

Labor  organizations'  demands,  124- 

127 
Law  and  the  broker,  19 

of  increasing  returns,  144 
Lawyers'  statement  to  bondholders, 

106 
Legal  investigations,  69 
Levee  district  bonds.  111 
Location  of  manufacturing  industry, 

217 
Lombard    Investment   Co.,    failure, 

204 
Losses  in  speculation,  33 
Lumber  industry,  changes  in,  224 

consumption  in  U.  S.,  222,  223 

extent  of  operations,  225 

organization  of,  224 

standing  timber  in  U.  S.,  223 

McCrum-Howell  Company,  failure, 

236-240 
Margin  speculation,  14,  18,  24 

chances  of  profit,  21 

safe  methods,  19 


287 


INDEX 


"Matching"  orders,  29 
Monopoly  of  control  of  raw  material, 
215 

example,  148,  149 
Mortgage  bank,  advantages,  203 

in  Germany,  illustration,  202 

in  United  States,  204 

Lombard  Investment  Co.  failure, 
204 

need  of,  203 

where  found,  203 

work  of,  203 
Mortgage  bondholder,  rights  of,  69 

nature  of  lien,  50-52 

given  by  business  corporation,  58 
Muck-raking  magazines,  11 
Municipal     Bonds:       careful     legal 
investigation     (Helena,    Mont, 
example),  104 

history  of  in  U.  S.,  100 

Lawrence  Chamberlain,  107 

lawyer's  statement  to  bond  house, 
106 

levee  district,  illustration.  111 

remedy  in  case  of  default,  113 

restrictions,  100-102,  110 

safety  of,  108 

security  of,  99 

special  assessment  bonds,  113 

tax  diitrict,  illustration.  111 

yields,  prevailing,  109 
"  Municipal  Bonds  Held  Void,"  103 
Municipal  ownership  and  operation, 

176 

National   banks   of   United   States, 
specie  holdings,  282 

Canada,  282 

South  America,  282 
Net  income  of  American  people,  36 
Newspaper  editorials,  12 
New  York  Central  &  Hudson  River 

Railroad,  profits,  138 
New  York  City  transit,  illustration, 

174 


New   York   merchant,    illustration, 

27 
Northern  Pacific,  bankruptcy,  272 
Notes   and    paper   outstanding,    in- 
dustrial corporations,  241 

Panic  of  1837,  94 
Patent  monopoly,  213 
Peckham,  Justice,  148 
Pennsylvania    Railroad    Co.,    com- 
pared with  U.  S.  Steel  Corp., 
120,  121 

freight  classification,  210 

profits,  138 
Personal  equation,  217 
Philadelphia  Exchange,  commissions 

26 
Philadelphia  Rapid  Transit  systems, 

143,  170-174 
Pools,  29,  30 
Population,  necessity  of  growth,  150 

increases,  198 
Powers  of  attorney,  41 
Powerlessness  of  small  stockholders, 

44 
Predictions,  difficulty  of,  29 
Price  movements:    decline,  271,  272 

increases,  262 

rising,  of  operating  supplies,  140 

Sauerbeck,  270 

wholesale,  106 
Price,  Theodore  H.,  261-266,  268 
Price,  Waterhouse  &  Co.,  159 
Privileges  of  stockholders,  41 
Professional  stock  market  educators, 

28 
Profit  regulation  by  state,  150 
Profitableness  of  gambling,  26 
Prosperity  of  past  ten  years,  150 
Prouty,  Charles  A.,  134 
Proxies,  41 

Public  Service  Commissions,  Act 
creating  Pubhc  Service  Com- 
mission of  New  York,  178 

attitude  of  financial  interests,  184 


288 


INDEX 


Public     Service    Commissions,    au-        Public  Service  Corporations,  reason- 


thority  over  issues,  178 
Buffalo,  Rochester  &  Eastern,  ex- 
ample, 181,  182 
favored  by  investors,  184 
methods  of  procedure,  179,  180 
protection  of  applicant,  ISl 
protection  of  investors,  183 
West  Shore  &  Nickel  Plate  Rail- 
road Co.,  illustration,  183 
work  of,  177 
Public  Service  Corporations,  audits, 
158 
bankruptcy,  166 

Chicago    Railways    Co.,    illustra- 
tion, 167,  168 
Consolidated  Gas  case,  150 
demand  greater  than  population, 

146 
depreciation,  159 
direct  offering,  155 
dividends,    Philadelphia    system, 

143 
engineers'  examinations,  157 
excessive  capitalization,  164 
gas  industry,  N.  Y.,  147 
Great    Northern    and    Northern 

Pacific,  152 
law  of  increasing  returns,  144 
monopoly,  148 

municipal   ownership   and   opera- 
tion, 176 
New  York  city,  illustration,   174 
obligations  of  public,  175 
Philadelphia    Transit    problemsi 

143,  170-174 
pledge  of  property,  155 
population,   necessity  of  growth, 

156 
prosperity,  143 
profit  regulation  by  state,  150 
prices  reduced,  165 
property  value,  160 
public  sentiment,  166 
righta  of  public,  175 


able  return,  151 
state     supervision,  161 
statement  of  lawyers,  159 
Seattle,  example,  156 
Wilcox  vs.  Consolidated  Gas  Co., 

148 
yield,  154 
Purchasing  power  of  gold,  265,  266, 

273 

Railroads,  building  and  rebuilding, 
123 

equipment,  124 

expenses,  124 

profits,  138 

proposition  to  I.  C.  C,  141 

regulations,  115 

stocks,  24 
Railway  Brotherhoods,  124-132 

efficiency,  maximum  not  reached, 
141 
Raw  material,  production,  279 
Reading  Railway  Co.,  illustration,  27 

bankruptcy,  272 
"Reasonable  return,"  151 
Reclamation  by  drainage,  199,  200 
Remedy  in  case  of  default,  113 
Repudiation  of  state  debts,  94-97 

illustration,  95 
Rights  of  mortgage  bondholder,  59 
Rule  for  selecting  stocks,  24 

St.  Louis  &  San  Francisco  default,  83 
Safest  investment,  107 
Sauerbeck,  Augustus,  270,  271 
Savings  banks,  investments  of,  49, 

109 
School  of  cooperation,  254,  255 
Schwab,  Charles  M.,  218 
Scientific  speculators,  31 
Seattle,  example,  156 
Security  jobber,  74,  75 
Sherman  law,  213,  244,  245,  248 
Shippers'  misdescriptions,  249,  250 


289 


INDEX 


Short  selling,  31 

Speculative  investments,  242,  243 
Special  assessment  bonds,  113 
Standard  Oil  Co..  244,  248,  249,  251- 

253 
Standard  securities,  201,  202 
Standing  timber  in  U.  S.,  223 
State  bonds,  93 

State  debts,  repudiation,  94-97 
State  supervision,  150,  161 
Statement  of  account  with  broker, 

illustration,  16,  17 
Stetson,  Francis  Lynde,  263 
Stock  brokerage  houses,  11 

inspection  of,  19 
Stock  Exchanges,  abuses,  12 

failures,  18 

proposed  abolishment,  12 
Stockholders'  privileges,  41 
Stocks,  advance  in  prices,  264-266 

rule  for  selecting,  24 
Straight,  W.  E.,  timber  expert,  229- 

230 
Subsidiaries,  earn  more  than  pay, 

140 
Suburban   Electric    Railroad,   illus- 
tration, 62-65 
Sugar  stock  purchase,  illustration,  25 
Suit    to    dissolve    company    whose 

stock  was  active,  23 
Supreme  court  decisions,  244,  248 

Tax  district  bonds,  111 
Taylor-White    process,   illustration, 

214 
Timber  bonds,  basis  of  security,  222 

consumption  of  lumber  in  United 
States,  222,  223 

illustration  of  Boston  bouse,  227 


Timber  bonds,  issued  against  exist- 
ing property,  226 
requirements,  227 
W.  E.  Straight's  report,  229,  230 
standing  timber  in  U.  S.,  223 
Trading   a   new   issue   for   an   old, 

example,  76 
Trunk  Line  petition,  I.  C.  C,  134, 

135 
Trusts,  centralized  management,  258 
cost  of  production,  257 
dissolution  of  Standard  Oil  C!o., 

252,  253 
economies   of  combination,   25S~ 

260 
evils  of  competition  in  prices,  254- 

256 
organization  of,  illustration,  246, 

247 
superiority  of  cooperative  methods, 

254,  255 
Supreme  Court  decisions,  244,  248 

Union  Pacific,  bankruptcy,  272 
United   States  Government  bonds, 

93,  251 
United  States  Steel  Corporation,  27, 

120,  121,  213,  215 
Unseasoned  bonds,  67 
Unsecured  creditors,  19 

Wall  Street,  methods  denounced,  11 
Water  Power  enterprise,  illustration, 

65 
West  Shore  &  Nickel  Plate  Railroad, 

illustration,  183 
White,  Stewart  Edward,  224 
Wholesale  prices,  Bradstreet's  com- 
pilation, 106 
Wilcox  vs.  Consolidated  Gas  Co.,  14 


UXiyERSITY  OF  CALIFORNIA  LIBRARY, 

BERKELEY 

THIS  BOOK  IS  DUE  ON  THE  LAST  DATE 

STAMPED  BELOW 

Books  not  returned  on   time  are  subject  to  a  fine  of 
50c  per  volume  after  the  third  day  overdue,   increasing 
to  $1.00  per  volume  after  the  sixth  day.     Books  not  in 
demand  may  be  renewed  if  application   is  made  before 
expiration  of  loan  period. 

' 
k 

r 

SEP  291«B   ^ 

^jT 

1 

i 

20in-l,'22 

VJK.a 


tVv         '     ^ 


2J)2249 


UNIVERSITY  OF  CALIFORNIA  UBRARY 


